A balance sheet is the best way to understand the internals of a company
I’ll explain it in less than 2 minutes using the purchase of a house
Thread:
I’ll explain it in less than 2 minutes using the purchase of a house
Thread:
Balance sheet has three components:
1) Assets
2) Liabilities
3) Equity
Let's go through each of these using an example of a home purchase.
1) Assets
2) Liabilities
3) Equity
Let's go through each of these using an example of a home purchase.
Let's assume you buy a home for $1M and you use $200K of your own money to buy the home and borrow $800K from the bank.
The sentence above includes the three components of a balance sheet. Here is the breakdown 👇
The sentence above includes the three components of a balance sheet. Here is the breakdown 👇
Assets:
An asset is something you own.
In our example, the asset you will own once you pay $1M to the seller is the home.
So you have an asset worth $1M.
An asset is something you own.
In our example, the asset you will own once you pay $1M to the seller is the home.
So you have an asset worth $1M.
Liability:
A liability is something you owe.
In the example, you borrow $800K from the bank and this is money you owe to the bank. So $800K is the liability.
A liability is something you owe.
In the example, you borrow $800K from the bank and this is money you owe to the bank. So $800K is the liability.
Equity:
Equity is your portion of the ownership. Or put another way, once you subtract the liabilities from the asset, it's what you are left over with.
In our example, $1M asset - $800K liability = $200K equity.
Equity is your portion of the ownership. Or put another way, once you subtract the liabilities from the asset, it's what you are left over with.
In our example, $1M asset - $800K liability = $200K equity.
The basic accounting equation is that assets must always equal the sum of liabilities and equity. Or put another way:
Assets = Liabilities + Equity
($1M) = $800K + $200K
Assets = Liabilities + Equity
($1M) = $800K + $200K
How does this relate you investing?
Well, any stock (or business) you purchase has a balance sheet.
Some common examples of assets and liabilities for a business are:
Well, any stock (or business) you purchase has a balance sheet.
Some common examples of assets and liabilities for a business are:
Assets: cash, receivables, inventory, equipment
Liabilities: bank loan, payables.
Liabilities: bank loan, payables.
You can analyze a business, for example, to see if it has enough assets to cover the liabilities.
If it does not, that could be problematic.
Balance shows you the strength of the financial position of the company.
If it does not, that could be problematic.
Balance shows you the strength of the financial position of the company.
There are two other statements important for you to understand as an investor:
1) Income Statement
2) Statement of cash flows
I'll cover these in a future thread.
1) Income Statement
2) Statement of cash flows
I'll cover these in a future thread.
That's a wrap!
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If you enjoyed this thread:
1. Follow me @practical_cpa for more of these
2. RT the tweet below to share this thread with your audience
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