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principles of finance. a la shmoop. the logic of balancing a sheet. all right

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will you taste it balance sheet light earlier in this course and now we're

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going in for the heavy French reduction sauces. you know the cream ones. in case [sauces simmer on the stove]

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you have the memory casing of a goldfish while we're reprinting the skeletal

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bones of the balance sheet from earlier right here. now here's the balance sheet

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for lemonade stands are us three days before the Super Bowl kickoff.

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alright skim through the numbers skimming skimming. let's take a little

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tour down balance sheet Lane and figure out how we actually apply these terms or

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concepts. well the first lines actually begin to tell the story of our little

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company. it was capitalized with a loan from grandmama that was originally

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granted as a one-year loan. today it's something less than a year, because it's

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current ie the principle of five grand is owed within the next year. and we also

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know that three grand of that five grand has been burned. we needed to build the

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stand by stools and you know all that jazz. well keep reading and we find the

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hundred grand peg, that's a lot of dough well the NFL promised to pay us a

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hundred grand if we delivered one hundred thousand cups eliminate to the

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game. but they're not paying us upfront so we have to front the cash for all the

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supplies, and yeah that's risky. the NFL could fire us at the drop of a hat and

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if they do we're bankrupt and then some. we'd never be able to pay back our Visa

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credit card bill grandmama and the cups vendors by just selling lemonade's in [credit cards get paid in a bankruptcy]

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front of our house at our stand. all right but if we do make this deal work

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it quote makes us unquote will have massive profits and be able to open five

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more lemonade stands. so we roll the dice as it were and pray a lot and hope for

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ha thirst inducing weather yeah Pro global. warming screw the polar bears.

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we really don't have any other assets at this point is we're skimming there's no

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brand value for our lemonade at Inc country time or Minute Maid or

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Grandmama's. it's just a name worth squat at this point. note that we have zero

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dollars in long-term debt. if grandmama had given us debt due in three years

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well then it would live in the long term line not the current one. and note that

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our long-term assets are PP&E- plant property and equipment -and in this line

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while the item is held as net not gross. usually. what does that mean?

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net well we said we'd burned two grand since starting the company. yes we've had

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sales and we've also had expenses but we've basically been running close to

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break-even thus far. we spent twelve hundred bucks on stools and stand six

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months ago, it's our gross value and we figure [balance sheet pictured]

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they'll last three years, and then break because someone will sit on them or play

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with them after hours and we're not watching the yellow dom.e so we think

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that 1,200 bucks original cost will be worth zero in three years and that it

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will decline in value arithmetically. in accordance with how most things like

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furniture or depreciated in accounting land. so if it goes to zero in three

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years than every six months while it will decline in value by 1/6

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well 1/6 of 1,200 bucks is $200 so we took $200 off the value of the $1,200 we

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started with, and now hold the value of our stools and signage as a grand on our

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balance sheet. so how do we best disclose these moving parts on the balance sheet?

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we show our work. we have a line for gross PP&E that'd be like 1,200 bucks in

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this case, and then we have a line for depreciation of PPE like 200 bucks there,

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and then like a line of net PP&E and that's like exactly our grand. all right

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get it got it good. note that we could have accounted for this depreciation

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value in other ways. we could have thought about it like will our signs and

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stools are worth a hundred bucks today on eBay. if we ever went out of business

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like if the NFL punted us tomorrow well the signs and stools would get

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liquidated on eBay. and so we should carry them today at their liquid value.[boy smiles behind lemonade stand]

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yeah not a stupid idea. sorry that was a bad voice. we won't do

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that again. in reality that logic is actually closer to the religion of GAAP.

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than not right you want to be the most conservative that you can. it's a

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realistic however there was one mitigating factor. we're not dead yet.

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that is at this moment anyway life is looking bright. the odds of the Super

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Bowl happening are high. and if it goes through as planned we make Bank. so since

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we are healthy ish we don't need to depreciate everything suddenly to just

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being liquidation value like that hundred-dollar thing on eBay. should

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things change however we'll want our finger on the red button to bring those

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values down fast. hopefully we don't have to do that it's not pretty.

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in the same vein note the little note on inventory that it's held at cost. well

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we'll have hated dime a cup for the massive cups, but

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if we had to turn around and sell them again on eBay or somewhere because all

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sales from cups are us are final, then we're likely to get less than a dime for

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them so shouldn't we hold the value of that inventory at less? no because we're

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still a going concern doing just fine. thank you very much. and we're optimist

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at heart and that's why we're entrepreneurs and not you know college

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professors or government workers or something. so let's take a pause here and [professor teaches class]

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add things up thus far in our little history. on the Left we have two grand in

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our Bank of America account a hundred grand in accounts receivable. we've build

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the NFL they've promised to pay the week after the Super Bowl.

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if 15 grand in inventory $1,000 in equipment the EE of PP&E all of the left

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side totals $118,000. okay Alex the right side for 500. all right well we have

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$5,000 in short-term debt tick-tick-tick it's coming due soon and

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grandmama will send the baseball bat boys if we don't pay. she's a tough old

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bird. ten grand payable to cups R Us five

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thousand dollars owed on our Visa card for buying sugar and lemons at Costco

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and that's about it. so on the right side we have a total of 20 grand.

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oh wait that's not balanced at all. isn't the right side supposed to equal the

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left like it does in the contested political states like Ohio and Florida?

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yes it is. well what's left is shareholders equity. well how do we get

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there well we just subtract the liabilities from the assets and we get

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118 thousand minus 20,000 equals 98 grams. that means our company's worth 98

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grand? well yeah kind of sort of. least the shareholders equity is. there's one more

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wrinkle we have to digest first. the equity of the company. see that was the

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easy Segway there. if you watch the opening of the sauce company and you [equity explained]

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don't have short-term memory issues well you'll recall that in order to

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capitalize the company to form it financially the founders wrote a check

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for a very small amount of money to buy common stock in their own company. in

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this case and let's say that our lemonade stand business is capitalized

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with 10 million shares at 100th of a cent each. why so many shares and why so

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cheap per share well we're glad you asked. the high number of shares allows

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us as a founder CEO financial manager to grant shares to employees who want to

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come on board later and help us grow the company.

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it also lets us not have to sell fractions of a share

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we find other investors who want to put money into us. for example if we

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capitalize the company with just 10 shares at $100 to start well then we'd

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write a check for a thousand bucks to capitalize the company, but what happens

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if we do really well and I don't know in a year an investor is willing to give us

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a company valuation of a million bucks and they want to buy 5% of the company

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for an investment of 50 grand? well we'd have to sell them half a share and yes

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that would be a pain. and the tiny amount per share reflects a few things. here

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first that we are not rich and don't have a ton of money to capitalize the

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company properly with an injection of a hundred grand or more of our own money. [lemonade stand stocks as example]

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we're tiny .and second that our common stock sits behind pretty much every

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other class of stock that other investors would buy in our company. if

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things go poorly and we have to sell while the bank's get paid first for

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their lines of credit, like grandmama then the bondholders get paid yeah,

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that's the grandma laughing, then the preferred stockholders like venture

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capital people get paid, and then at the very end of the brown rainbow we get

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paid our common which is likely a lot of nothing. so we don't want to have a ton

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of financial exposure to common stock at this point via our hard-earned cash

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savings. we'll own 100 percent of the common stock on day one anyway we're the

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sole founder here. so with ten million shares at a hundredth of a cent each

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we've written a check to the company for a grand.

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note that the notations then under the shareholders equity lines our retained

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earnings are ninety seven thousand dollars yeah it's a lot an enormous

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value we've created in a short time. Thank You Super Bowl contract .if the

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Super Bowl goes well and we actually get paid we're stylin. [stacks and stacks of cash]

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all right when you see the word other. you should split your brain in half half

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of it should just ignore the term and the other half should get all uptight

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about it all. right here's to the uptightness.

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note that other comes up a bunch in all flavors of statements. income cash flow

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and balance sheets note here that other short-term assets could be things like

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prepaid rent or prepaid insurance or prepaid power gas and electric bills.

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dicey startup companies are often asked to pay for things well in advance

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because war-weary landlords have too many scars from small companies sneaking

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off into the night and not paying the rent they owed last month. right but

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think about how prepaid rent could should be is

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asset. and it could be long-term and short-term right you have three year

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prepaid rent on a place for three grand a month 36 months. you are funded by

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venture capitalists and at that time you were swimming in cash. the time you know

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when you set the rent deal with landlord. in order to get into the best building

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in town at a nice discount per month you had to pay all three years of rent in

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advance. that's 36 months times 3 grand or 108 thousand bucks .well at the moment

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you sign the lease and paid the dough you had a short-term or current asset 12

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times 3 grand 36,000 that was current asset got it and a long term asset of 72 [equations]

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grand. the remaining 24 months a year or more later at 3 grand a month. all right

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as the first 24 months went by the value of long-term asset gradually declined to

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zero, and then when there was one year left on the lease it was $36,000 as a

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current asset. well funky things happen in big bull markets with regard to rent.

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as well oftentimes if long-term rentals happen at the bottom of a bad market the

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value of the real estate goes up a lot as time goes by and in theory companies

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could quote flip unquote their leases to the market which was paying 3 grand a

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month but currently would be happy taking over the lease for 5 grand a

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month. in theory companies could mark to market a gain of their current assets in

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the rent lease thing, but since they almost never intend to move out of their

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offices during the time of their lease and moving costs are usually really high,

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in a pane they just leave the numbers as they are but you should know about all

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that stuff so you get all this information from shmoop for no extra

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cost what a deal. all right liquidity is a hugely important concept to understand [man straightens tie]

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and be able to apply as well it's such a big deal that balance sheets are

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organized under its auspices. note how our balance sheet is laid out. cash comes

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first then accounts receivable then inventory then other think prepaid rent

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here then long-term assets like PP&E and lastly other long termers. did things

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happen in this order by accident? no not on your life. they're organized by

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liquidity and there are really two reasons for that

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well first should the company have to be liquidated the easy to sell stuff is

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almost always the most liquid stuff and second the values of the more liquid

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stuff are way tighter. meaning it become eighty-three thousand two hundred thirty

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one dollars in cash in the bank well that cash is worth eighty three

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thousand two hundred thirty one dollars. very liquid very precise not a lot of

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debate no worries about conflicts of interest in selling that cash or

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transferring it or whatever .it's worth what it's worth. but what about a 14-year

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old tractor smelting plant or a 22 year old newspaper printing plant. well they

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both still function but like what are they worth on eBay? the company paid a

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million dollars for the printing plant twenty two years ago is it still worth

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the million? well prices have gone up a ton over that time with inflation

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printing plants are rare maybe the parts are worth a lot. or is it just scrap [value chart pictured with inflation factored in]

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metal worth 10 grand waiting to be hauled away at a price and then melted

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down. hmm very wide range there. low liquidity

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low precision. anyway if you think about it cash would be super easy to liquidate.

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an account receivable would be like collecting from the NFL the dough they

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already committed to paying assuming the company performed on delivering that

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service the a hundred thousand drinks and in order to show it as a receivable,

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the service would have had to have been performed and delivered then collecting

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from the NFL, well at that point should be very liquid. yeah it may take 30 days

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but it's a pretty clear and safe bet to happen the NFL pays its bills alright.

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then we go to inventory hmmm. this is harder who's gonna buy a million cops

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and 5,000 pounds of sugar or whatever amounts you have on your books when you

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go bankrupt. well tough to sell so the numbers get vague here really fast in

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the form of the value you are carrying that inventory at Book value or what you

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paid for it versus what the market will actually pay for [book value defined]

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I don't know used sugar. what would they pay you in cash to buy all that used

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cups anyone? yeah we think. not alright the others follow similar suit a

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four months tail on a lease ain't worth much on the market. it's the league of

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the 22 year old newspaper printing press thing not at all liquid. big discounts

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big write downs at bankruptcy time and maybe big bargains for whoever is in the

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market to buy a slightly used newspaper printing press. all right let's go back

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to our balance sheets. most recent iteration and now look at this newly

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updated one as of this morning. well so what happened here people well duh the

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Super Bowl happened. Green Bay won forty two two three on a mercy field goal for

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the other team at the end the NFL paid the inventory was used Grandmama's loan

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was fully paid off the liability of ten grand to the cups

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vendor and 5k to the Visa card and everything else it all adjusted. now how

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much cash is in the bank? well a whopping $82,000 the value being held for the

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stools didn't change and still about a grand everything else evaporated. and

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note that the shareholders equity here is 82 grand. that is more or less the

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company's entire Book value but a company that just generated such [balance sheets compared]

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enormous pre-tax profits in such a short time, has to be worth a lot more than

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$82,000 right? the market value of the company is a reflection of what an

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outside investor would pay for a given percentage ownership of the company. if

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you were thinking about raising capital at this moment with such a great

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business momentum going well it's probably not a bad time to raise that

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capital. there's one key and very important liability missing the above

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sheet. any guesses right rhymes with sh max ? yep tax well you just made 50 grand

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and change in profits you think the g-man is gonna let you keep all that

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money guff ah. not gonna happen so if you live in a blue state assume you'll pay

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about 30 percent of that 50 grand in taxes and well you should plug a fifteen

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thousand dollar current liability of taxes payable here so it's obvious

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you're thinking about it. no matter what kind of nightmares it gives you. [fancy car crashes]

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