Fundamentals of Business Accounting 1: Learn Quick and Easy | Claudiu I. | Skillshare

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Fundamentals of Business Accounting 1: Learn Quick and Easy

teacher avatar Claudiu I., Entrepreneur | Author | Trainer

Watch this class and thousands more

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Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Watch this class and thousands more

Get unlimited access to every class
Taught by industry leaders & working professionals
Topics include illustration, design, photography, and more

Lessons in This Class

14 Lessons (1h 44m)
    • 1. Course Introduction

      5:45
    • 2. What Is a Profit and Loss Statement?

      4:20
    • 3. The Structure of the P&L Statement and Terms Used

      5:50
    • 4. Building & Analyzing a P&L Statement

      12:18
    • 5. What Is a Balance Sheet?

      4:00
    • 6. The Structure of the Balance Sheet Statement and Terms Used

      8:49
    • 7. Building & Analyzing a Balance Sheet Statement

      8:01
    • 8. Depreciation & Amortization of Assets

      8:57
    • 9. What is a Cash Flow Statement?

      8:12
    • 10. The Structure of the Cash Flow Statement and Terms Used

      9:43
    • 11. Building & Analyzing a Cash Flow Statement

      10:18
    • 12. Accounting Principles P&L

      6:30
    • 13. Accounting Principles Balance Sheet

      7:45
    • 14. Final Thoughts!

      3:49
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About This Class

Are you an entrepreneur?

Does accounting seem overwhelming?

Do numbers and financial reports confuse you?

Would You like to learn accounting & finance in a fun & easy way?

Or maybe you are a small business owner who wants to measure and improve your business performance?

Do you want to master finance concepts without spending a lot of your time on books and long-hour boring courses?

If you answered "Yes" to any of the above, you should stop here. This is the right course for you!

This course is easy to understand and it's designed in explainer video format to convey financial fundamentals in a way that makes everything clear and understandable. You will receive detailed explanations and templates. The course starts by introducing accounting basics and then teaches you to understand financial statements.

Stop thinkingĀ and build your financial fundamentals!

This course is the best way to start learning the fundamentals of business accounting.

Don't go on wondering "what would have happened if I did". You won't be disappointed. What have you got to lose?

You will get:

  • Handouts of all course materials that make it easy to study and remember

  • Quick & Helpful SupportĀ 

    Stop thinkingĀ and build your financial fundamentals!

Meet Your Teacher

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Claudiu I.

Entrepreneur | Author | Trainer

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Transcripts

1. Course Introduction: Hello everyone and welcome to this course in which I will teach you the fundamentals of business accounting. My name is Claudiu Ivan and I am an entrepreneur, author and trainer. In the past, I've talked to many entrepreneurs or people who wanted to start a business, and I was surprised that they didn't know how to answer basic questions about their business finances. Their answers were "go and talk with my accountant, he knows everything about my business finances." OK, that's right. But it's your duty to know basic information about your business finances. For example, what is your gross margin? What is your EBITDA? Which is one of the most important terms. What is your net profit, working capital or your monthly free cash flow? What I've said here is the basic information that you should know. But don't worry. That's why I have created this course. To help you with your basic fundamentals of business accounting. Now, who is this course for? Startups, small business owners, entrepreneurs, college student, working professionals, accountants, business managers or supervisors and anyone else who wants to learn more about accounting and finance. The course is created as explicitly and simple as possible to better understand everything. I will explain and show you how to build and to complete each statement to better understand. If you find yourself in one of these, this course is right for you. Things you will learn in this course. Accounting terminology and fundamentals. We will have a video for each statement where I explain every term used, and I will give many examples to understand what each one means. Learn the different types of financial statements. We have three types of financial statements: profit and loss statement, balance sheet and cash flow statement. We have a complete section for each financial statement. Learn the main difference between profit and cash flow. It's possible to be profitable and have negative cash flow at the same time. In this course, we will discuss the difference between profit and cash with examples to better understand. Read an income statement or P&L statement, balance sheet and cash flow statement. At the end of the course, you will know how to read any financial statements of any company. Understand what gross margin is, why it is important in an organization and how to calculate it. Gross Margin is an important profitability indicator. Companies use gross margin to measure how their production costs related to their revenues. And understand what is Working Capital and Free Cash Flow. Working capital is a measure of a company's liquidity, operational efficiency and its short-term financial health. Working capital and free cash flow are important terms because it indicates you if your company has cash available to invest and what are your current liabilities and long term liabilities. This course will help you to identify problems in your company, improve the performance of your business, have a more complete picture of your company and its competitors. Now, let's move on to the course structure. The course is divided into three sections. The first section is profit and loss statement. We will discuss what is a P&L statement, the structure and terms used in P&L with examples of course and finally, I will build a P&L statement from scratch with you. At the end of each section, you will have to complete a test. It will be a very brief recap. We will do the same for balance sheet and of course, for cash flow statement. Once you know every statement and use them, I'm sure that you'll be another person and you'll change your business profitability and so on. What things you'll need to get started? Basic Microsoft Excel skills. We will use Microsoft Excel for financial statements. Desire to learn accounting and finance. Absolutely NO experience/understanding of financial statements or accounting is required. This course starts from the basics. And no materials required. I will give you many materials to get started. Templates, definitions, etc.. And what you will get. Lifetime access to the course. Access the course from any online device. Even if you have a phone, a tablet, a computer, you will be able to access the course from all of them. My full support for every question or issue. I will answer your questions as quickly as I can. And finally, 30-day money-back guarantee! You have no risk guys! Try it and if you don't like the course, you have a 30 day money back guarantee. Thank you so much for watching. Stop thinking, enroll up today and build your financial fundamentals! Let's get started, guys. 2. What Is a Profit and Loss Statement?: Hello and welcome to this new lesson! In this lesson, I want to talk to you about what is a profit and loss statement and why do we need it? A profit and loss statement, also known as an income statement, is a financial report that displays your total income, total costs (what you pay to produce your product or perform your service), total expenses (what you pay in overhead), and net income for any given time period. You can generate a profit and loss statement for any time period. But the most common time frames are monthly, quarterly and annually. Don't worry, I will show you exactly how to create a Profit & Loss statement and how to analyze it. For the moment, let's move on to the next slide. Why do we need a profit and loss statement? At its most basic level. a profit and loss statement shows if your business is profitable and if your business model is sustainable. If you have a profit, it means that your business is earning more than it spends. If you have a loss, it means that your business is spending more than it earns. You can use a profit and loss statement to answer overarching questions about your business strategy, such as: Do I have enough revenue to cover my costs and expenses? Do I have a high return on investment for my expenses? Does my business earn enough money to pay me the owner? These are important questions. Your profit and loss statement can also give you insights about the details of your day to day operations, like: Your top earning revenue streams, your gross margin, and I will define this term in the next video, your lowest earning revenue streams, your top spending categories and so on. Over time, your profit and loss statement can also show you: your business's growth over a specific period of time, the areas of your business impacting its revenue growth, the areas of your business impacting its profitability, sales trends and patterns. Of course, you can get all of this from one little report, which is why a profit and loss statement can be so impactful for small business owners, and not only. Now, what isn't shown on the profit and loss statement. A P&L statement only shows your income, costs and expenses. Assets, liabilities and equity do not appear on the report. Assets can include: purchases of furniture, equipment, machinery, tools, vehicles, money lent to others. Liabilities can include: credit card payments, loan payments, sales tax payments. Equity can include: owner distributions, money invested by the owners (which is capital). Many people confuse profit with cash that's available to spend, but the two are not the same! That's why it's important to understand what is not included in your profit and loss statement. You can have profit and still have a negative cash flow, especially if you have a lot of liability payments or need to take owner distributions. If you see a profit on your report, don't assume that all that money is available for you to spend! But don't worry. By the end of this course, you will understand the difference between these two concepts. See you in the next video where I explain the structure of the P&L statement and terms used. See you there. 3. The Structure of the P&L Statement and Terms Used: Welcome back! In this lesson, we'll talk about the structure of the P&L Statement and terms used. A profit and loss statement has eight sections: revenue, cost of goods sold, gross margin, OPEX, EBITDA, EBIT EBT And net profit. Here we have one example. Don't be scared. At first glance, it seems difficult, but it's not at all. We will practice so that you understand better. Revenue, COGS, OPEX and EBITDA. All of these sections are structured the same way. There is a line for every income or expense category and subcategory that you use in your business. Each line shows you the total earned or spent in that category for the time period that you are creating the P&L statement for. Let's define each term used in the P&L. Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations. Revenue, also known as gross sales, is often referred to as the top line because it sits at the top of the income statement. Cost of goods sold refers to the direct costs of producing the goods sold by a company. This amount includes the cost of the materials and labor directly used to create the good. It excludes indirect expenses, such as distribution costs and sales force costs. Cost of goods sold is also referred to as "cost of sales". COS Gross margin. Gross margin represents the difference between the revenue obtained from the sale of a good and the cost of acquisition or production of that good. The higher the gross margin, the more capital a company retains on each dollar of sales, which it can then use to pay other costs or satisfy debt obligations. Companies use gross margin to measure how their production costs relate to their revenues. For example, if a company's gross margin is falling, it may strive to slash labor cost or source cheaper suppliers of materials. Alternatively, it may decide to increase prices as a revenue increasing measure. OPEX (also operating expenses) are the costs a company incurs for running their day-to-day operations. These expenses must be ordinary and customary costs for the industry in which the company operates. Example of OPEX may be: rent and utilities, wages and salary, accounting and legal fees, administrative expenses, property taxes and business travel. EBITDA (earnings before interest, taxes, depreciation and amortization). Is a measure of a company's overall financial performance and is used as an alternative to net income in some circumstances. It's a more precise measure of corporate performance since it's able to show earnings before the influence of accounting and financial deductions. EBITDA can be used to analyze and compare profitability among companies and industries, as it eliminates the effects of financing and capital expenditures. EBITDA is often used in valuation ratio and can be compared to enterprise value and revenue. EBIT (earnings before interest and taxes) is a company's net income before income tax expense and interest expense have been deducted. EBIT is used to analyze the performance of a company's core operations without tax expenses and the cost of the capital structure influencing profit. EBT (earnings before taxes) reflects how much of an operating profit has been realized before accounting for taxes. By removing tax liabilities, investors can use EBT to evaluate the firm's operating performance after eliminating a variable outside of its control. Net profit represents the difference between all the incomes and all the expenses committed for obtaining those incomes in a certain period. If your net income is positive number, it means that you earned more than you spent and you have profit. If your net income is negative number, it means that you spent more than you earned and you have a loss. You don't have to memorize the definitions, all the definitions. But you have to know what does it mean each term. If someone asks you what is your EBITDA, you have to know the answer. Now you know the terms. Let's move on to the next video where we build a P&L statement with numbers. 4. Building & Analyzing a P&L Statement: Hello and welcome to this new lesson! In this lesson, we will build and analyze a P&L statement. From time to time, I will define the term so very simply, to remind you what each one means. On the right side, we have the formulas for every terms. But for the moment, let's get started! Suppose we have a company that sells donuts, juice and other products. I will complete the table from the top to bottom, starting with the revenue. Revenue is the total amount of income generated by the sale of goods or services related to the company's primary operations. Let's say, we made one hundred thousand dollars in January. We can divide the total revenue in subcategories such as donuts and other products. Other products. We sold donuts for eighty thousand dollars and other products (juice, water) for twenty thousand dollars. The table would look like this. If you divide the sources of income, you will have greater clarity on the business. You will know exactly which category, subcategory is more profitable. Let's move on to the COGS. We will discuss about revenue growth rate, this box, at the end of the course. Cost of goods sold refers to the direct cost of producing the goods sold by a company. If you remember, this amount includes the cost of the materials and labor directly used to create the good. Let's say we have a supplier who brings us all the necessary ingredients for donuts (flour, eggs, milk) etc.. So ingredients. And other supplier for drink, other product. Excellent. Cost for ingredients would be twenty-five thousand dollars and cost for another product, for other products would be five thousand dollars. So we have a total of thirty thousand. Now we have to calculate gross margin. The formula is here. Gross margin represents the difference between the revenue obtained from the sale of a good and the cost of acquisition or production of that good. Simply, gross margin equals revenue minus COGS. And we have seventy thousand dollars. To calculate the percentage GM, the value of gross margin, divided by revenue, and multiplied by one hundred. And we have seventy percent gross margin, which is very, very good. Further, we have OPEX or operating expenses. Are the costs a company incurs for running their day-to-day operations. In OPEX we have rent because we need a place to sell, we have salaries for employees, we have accounting, we have utilities, And we have, I don't know, business travel. Excellent! OPEX could be forty thousand dollars. Rent five thousand dollars, salaries thirty thousand dollars, accounting one thousand, utilities three thousand and business travel one thousand. So we have a total of forty k dollars (40.000$). EBITDA. Or earnings before interest, taxes, depreciation and amortization. Is a measure of a company's overall financial performance and is used as an alternative to net income in some circumstances. The formula for EBITDA is: GM, minus OPEX. And we have thirty k (30.000$). The percentage EBITDA is 30 percent. We have the formula here. Let's say EBITDA, revenue and multiplied by one hundred. And we have thirty percent EBITDA. Amortization is an accounting technique used to periodically lower the book value of a loan or intangible asset over a set period of time. In relation to a loan, amortization focuses on spreading out loan payments over time. When applied to an asset, amortization is similar to depreciation. Depreciation is an accounting method of allocating the cost of a tangible or physical asset over its useful life or life expectancy. Depreciation represents how much of an asset's value has been used up. Depreciating assets helps companies earn revenue from an asset while expensing a portion of its cost each year the asset is in use. Let's assume that we don't have amortization and depreciation. We bought our machine with cash, no credit. So zero and zero. EBIT (earnings before interest and taxes) is a company's net income before income tax expense and interest expense have been deducted. We have the formula here, EBIT. EBIT = EBITDA minus the sum between amortization and depreciation. So we have 30 K dollars (30.000$) because we have zero here. And the percentage is the same 30. Many companies have interest to pay. In our example, we have to pay five thousand dollars a month. EBT is the difference between EBIT and interests. And we have twenty five k dollars (25.000$). It's mandatory to pay our country taxes. It's about the income tax. In many countries, if you have over one million euros in income, you have to pay one percent of the income. It's not too much. But we must pay the taxes. So we have one percent, from revenue. And we have one k (1.000$) to pay. And finally, net profit. Is the difference between EBT and taxes. We have twenty four K (24.000$). It's not bad at all. The percentage of the net profit is twenty four. So we will have here twenty four percent. Also the formula is here. The net profit is the one that can be taken out of the company through dividends. You can reinvest all the profit or you can only get a part of it. After going through all the terms, I have some recommendations to make. GM must be over 70% because it follows the OPEX section where there are many important expenses. A great GM allows you to make investments and gives you the assurance that you can survive hard times. If your GM is small, you have to raise the price of your product or you have to find a cheaper supplier with very good products. Monitor and record every income and expense you have in the table. It will give you a very good overview and you can make excellent financial decisions. Now, let's discuss a little bit about revenue growth rate. This box. Revenue growth rate measures the month-over-month percentage increase in revenue. It's one of the most common and important startup metrics. The revenue growth rate provides a solid indicator of how quickly your startup is growing or your business is growing. Let's calculate an example. The formula for revenue growth rate is here. So. Let's say in February, our revenue is one hundred fifty thousand dollars and in March is two hundred thousand dollars. Let's calculate the revenue growth rate from month to month. We compare the February with January. Equal February minus January, divided to January, multiplied by 100. And we have 50 percent growth from January to February. Now, let's compare the March to February. Again, we have March minus February, divided to February, multiplied by 100. And we have thirty-three point thirty-three percent. Again, we compare February with January, then March with February, not March with January, because we want to know the growth from month to month. And that's it. It's so simple to create and monitor a P&L statement. It's your turn to create one. Let's do it. 5. What Is a Balance Sheet?: Hello and welcome to this new lesson! In this lesson, I want to talk to you about what is a balance sheet and why do we need it. A balance sheet is a report that gives you a snapshot of the financial health of your business. Unlike a profit and loss statement, which shows you what you've earned and spent in a given time period, a balance sheet shows the whole picture of your finances. A balance sheet lists your total assets (what you own), total liabilities (what you owe others), and equity (what part of the business you personally own) at any point in time. It can also be referred to as a statement of the net worth, or a statement of financial position. The balance sheet is used alongside other important financial statements, such as the income statement and statement of cash flows in conducting fundamental analysis or calculating financial ratios. The balance sheet is based on the fundamental equation: assets equal liabilities plus equity. This formula is intuitive. A company has to pay for all the things it owns (which is assets), by either borrowing money (taking on liabilities) or taking it from investors. Now, why do we need a balance sheet? Reading a balance sheet can help you answer overarching financial questions like: How much liquid assets does my business have and how much is my business worth? A balance sheet can also help you answer Cash-Flow questions like: How much money do others owe me that will be paid in the near future? or How much money is available after paying my current liabilities to put back into my business? A balance sheet is often used by lenders and investors to see the financial risk of investing in your business. If your company has more liabilities than equity, it appears riskier. If the business is becoming more or less solvent over time. And also, investors want to see, is the debt-to-asset ratio increasing or decreasing? These are important questions. Balance sheets help current and potential investors better understand where their funding will go and what they can expect to receive in the future. Investors appreciate businesses with high cash assets, as this insinuates a company will grow and prosper. And finally, balance sheets are also important because these documents let banks know if your business qualifies for additional loans or credit. As you can see, it's not enough to know just the P&L statement. You have to know balance sheet too. Let's see what isn't shown on a Balance sheet. As you already know, the balance sheet shows your assets, liabilities and equity. Total revenue, total costs and total expenses are parts of the P&L statement. It's important to understand the difference between these two statements. P&L shows us the profitability of the business and the balance sheet shows us the worth of the business. In the next video, I will explain the structure of the balance sheet and terms used. See you there! 6. The Structure of the Balance Sheet Statement and Terms Used: Welcome back! In this lesson, we will talk about the structure of the balance sheet and terms used. A balance sheet has three main sections: assets, liabilities and equity. Here we have one example. At the very bottom of your balance sheet, you'll see a line that says total liabilities and equity. Which is the same as your total assets. And that's because a balance sheet needs to balance! All of the money in your business needs to be accounted for through the basic accounting equation: assets equal liabilities plus equity. Unlike a profit and loss report, which shows your net income on the final line, the last line of the balance sheet shows that your accounting is indeed, balanced. If you add up your liabilities and equity and they don't equal your total assets, that means there is a serious problem in your accounting that needs to be addressed. Balance sheet shows a really detailed list of everything that you own and everything that you owe. Now, let's define each term used in balance sheet. The first section of a balance sheet shows your assets. Assets are everything that your business owns. There are two types of assets: current and long term. A current asset is anything that can be converted to cash within 12 months. Sometimes you'll hear this called a liquid asset. A long term asset is something your business owns that takes longer to convert to cash, also referred to as an illiquid asset. The assets section of your balance sheet is organized from most liquid assets to least liquid assets. That is, the assets that can be most readily turned into cash (like money in your bank account) appear at the top. Assets that take longer to convert to cash (like land that you own) appear towards the bottom. Now, current assets. There are three main types of current assets: cash, inventory, accounts receivable. Cash is the money you have in your bank account. Inventories are items that you have available to sell. If it's sitting on the shelf in your boutique, it's going to appear as an asset on your balance sheet. Accounts receivable is money that is owed to you from your customers. If you invoice someone for one thousand dollars and they have 30 days to pay you, that one thousand dollars appears on your balance sheet as accounts receivable until the invoice is paid. And of course, we have other types of current assets like undeposited funds (money that has been paid to you but has not been deposited into your bank account), short term investments and stocks. After the current assets section, you will see your long term assets. On a balance sheet, long term assets appear as: investments (these are long term investments that cannot be converted to cash in the next 12 months). We have fixed assets (for example, property, equipment, vehicles, machinery and so on), and intangible assets (trademarks, patents, brand name, etc). When looking at our balance sheet, it's important to pay attention to more than just your total assets. You should also look at how much of your assets are current versus long term. For example, if you have fifty thousand dollars in total assets, that might feel like a lot. But if only five thousand dollars is in current assets, it means that your business doesn't have a lot of cash readily available. The second section of your balance sheet shows your liabilities. A liability is anything that your business owes to others. And just like assets, there are two kinds of liabilities: current and long term. Current liabilities are debts that can be settled in the next 12 months. Long-term liabilities are debts that will be settled in more than 12 months. And the liabilities section of your balance sheet is ordered from your most current liabilities to the most long term ones. At the top of the liabilities section are your current liabilities. Common current liabilities include: accounts payable, short term loans, credit card balances. Accounts payable is money that you owe others. Usually, this is money that you owe for goods or services that you've received, but not paid for yet. If you work with vendors who give you a certain number of days to pay your invoice, then you have an account payable. Short term loans are loans that you expect to pay back within one year. A common example is a business line of credit. You borrow that money when you need it and then pay it back within a few months. Then there are credit cards. Because credit card spend is supposed to be paid back quickly, they are among the most current of your liabilities. And next, you will see your long term liabilities. These are debts that cannot be paid in full in the next 12 months. Examples of long term liabilities are business loans with terms longer than 12 months, tax liabilities, mortgage on a building or property. Just like it's important to differentiate between current and long term assets, it's important to know the amount of your current liabilities and long term liabilities. Your current liabilities are your immediate concern is this debt needs to be paid in the next 12 months. Your business needs to make enough money to cover these payments while also continuing to make payments on your long term liabilities. The last section of your balance sheet is the equity section. It shows your share of the business's total assets. In other words, how much money you would receive if all the business's assets were liquidated and liabilities paid off. This is often referred to as the net worth of your business. Here is an easy way of thinking about equity. Equity equals total assets minus total liabilities. If it's a positive number, you have more assets than liabilities. If it's a negative number, you have more liabilities than assets. Just like assets and liabilities, there are different types of equity on a balance sheet. The most common are owner's draw or shareholder distribution, owner contribution or shareholder contribution, net income and retained earnings. Owner's draw represents how much money the owner has taken out of the business over time. Owner contribution represents the money that the owner has put into the business over time. Net income is the amount of money that your business has earned after its costs and expenses. In other words, your business's profit. Retained earnings is the business's profit that's not taken out of the business by the owner, but rather left in the business for investment. For example, if your business profit is one hundred thousand dollars and your owner's draw is thirty thousand dollars, then you're retained earnings for that accounting period is seventy thousand dollars. Excellent. Now you know the terms. Let's move on to the next video where we build a balance sheet with numbers. 7. Building & Analyzing a Balance Sheet Statement: Hello and welcome to this new lesson! In this lesson, we will build and analyze a balance sheet. From time to time, I will define the term so very simply, to remind you what each one means. So let's get started! We will take again the example of a company that sells donuts. Our donuts company. I will complete the table from top to bottom, starting with current assets. And if you remember, the assets section of a balance sheet is organized from most liquid assets to least liquid assets. The assets that can be most readily turned into cash appear at the top. Assets that take longer to convert to cash appear towards the bottom. Assets are everything that your business owns. And of course, the current assets would be cash, inventories and accounts receivable. All the numbers from here are fake, but I want you to understand the logic behind these terms. Our donuts company has Let's say. Twenty thousand dollars in cash. And inventories. Would be five thousand, because we have some donuts on the stock. And we have no accounts receivable because we receive the money on the spot. Total current assets would be twenty-five thousand. Next are long term assets. On a balance sheet, long term assets appear as investments, fixed assets, intangible assets. Let's assume that we don't have long term investments, but we have fixed assets and intangible assets. When you have to put long term assets in the balance sheet, you have to put them at their purchase price! If you bought equipment for one hundred thousand dollars, the equipment will appear in the balance sheet with one hundred thousand dollars. It's the principle of historical cost. In our case, fixed asset would be a machinery. Machinery, which worth ten thousand. A property, let's say. Which worth, fifty thousand. One vehicle to deliver donuts, so we have vehicle, which worth three thousand. Intangible assets would be our trademark, so we have to TM which worth one thousand. And domain, domain name which worth one thousand. Total long term assets worth thirty k, thirty thousand (30.000$). It's not bad at all. Now, the formula for total assets is: total current assets plus long term assets. And we have fifty five thousand (55.000$). It's very simple, right? The second section of our balance sheet is liabilities. A liability is anything that your business owes to others. Just like assets, the liabilities section of our balance sheet is ordered from our most current liabilities to the most long term ones. At the top of the liabilities section are our current liabilities. Common current liabilities include accounts payable, short-term loans, credit card balance. With our donuts company, we have business credit. Worth fifteen thousand. And credit card. Worth ten thousand. Total current liabilities would be twenty-five thousand. Next are long term liabilities. These are debts that cannot be paid in full in the next 12 months. Example of long term liabilities are business loans with terms longer than 12 months, tax liabilities, mortgage on a building or property. In our case, we have a business loan worth I don't know, twenty thousand, let's say. And total long term liabilities is twenty thousand. The formula for total liabilities is: total current liabilities plus total Long-Term liabilities. So we have forty five thousand. Just like it's important to differentiate between current and long term assets, it's important to know the amount of our current liabilities and long term liabilities. Your current liabilities are your immediate concern as this debt needs to be paid in the next 12 months. And finally, the last section is the equity section. It shows your share of the business's total assets. Types of equity are owner's draw, owner contribution, net income and retained earnings. Let's assume that we contributed seven thousand dollars at the beginning of the business. So we have owner contribution seven thousand. And the net profit is three thousand dollars. Total equity would be ten thousand. And the total equity plus liabilities is fifty-five thousand. Our total liabilities and equity are the same as total assets. That's because our balance sheet needs to balance. All of the money in your business needs to be accounted for through the basic accounting equation: Assets equal liabilities plus equity. The fundamental equation. And that's it. It's so simple to create and monitor a balance sheet. It's your turn to create one. Let's do it! 8. Depreciation & Amortization of Assets: Welcome back! In this lesson, we will talk about depreciation and amortization of assets. Amortization is an accounting technique used to periodically lower the value of a loan or intangible asset over a set period of time. When applied to an asset, amortization is similar to depreciation. That's why we have depreciation and amortization in title. How do we calculate the monthly depreciation if, for example, we bought a vehicle with 3k (3.000$) three thousand USD. We must first determine how long we will use this vehicle. In our example, we will use it for 5 years. If we use it for 5 years, it will not be consumed in the month of purchase because there is no need for a new car every month. This means that only a part of the value of the vehicle contributes to the sale in the month, and this represents the depreciation or amortization expense. Amortization is, therefore, a piece of the value of a high-value asset, which a company uses for many years to obtain income. The monthly value of the depreciation expense is calculated by dividing the value of the respective good by the number of months for which it is estimated that it will be used. In our case, we paid 3.000 USD per vehicle and we will use it for 5 years. So we will have 3.000 divided by 5, divided by 12 (number of months in a year, and we want to see how much would come per month), and we will have 50 USD monthly depreciation for the vehicle. It's a very simple calculation. That's what you have to do with every asset. Next, we'll discuss the gross and net book value. Now that we know how to calculate depreciation, what value will we put in the balance sheet? As I said, the vehicle is a long-term asset and we expect to use it for 5 years, that is 60 months. The asset is gradually consumed and therefore, in P&L will appear only the value of 50 USD per month. Obviously, at the end of a month, when we have the inventory list, the vehicle is no longer new, we used it and consumed a part of it, that means 50 USD out of 3000 it was worth at the time of purchase. Therefore, the value of the vehicle at the end of the next month is lower, having to deduct the depreciation, its current value being 3.000 USD minus 50 USD, that is 2.95K (2.950$). Also in February, we subtract another 50 USD and we'll have 2.9K (2.900$). And you will note in the balance sheet the value of 2.9K (2.900$) next to the vehicle for February 2020. The amount with which the vehicle was bought, the 3.000 USD, is called gross book value. The 2.95 USD (2.950$), how much the vehicle is worth from the accounting point of view at the end of the month, is called the Net Book Value. The gross book value of a long term asset consists of all expenses necessary to bring the asset into use for business purposes. In our case, the gross book value is 3K (3.000$). For more complex equipment, the gross book value is given by the price of the equipment, to which is added the transport to the company's headquarters and the expenses for the installation of the equipment provided by a company with expertize. Two simple terms, right? In the financial reports and analyzes, we will find the long term assets of a company always at the net book value, that is the gross book value minus the accumulated depreciation. As I said, for our example, we'll note in the balance sheet next to the vehicle the amount of 2.95 USD (2.950$), in February 2.9 USD (2.900$), in March, 2.85 USD (2850$) and so on, until the asset is consumed in full. But what happens next? At the end of the period, we can still use the vehicle without calculating the depreciation in the table, we can sell it and note in P&L the respective sale or there is the variant in which the vehicle is degraded and we cannot use it at all. So it will be scrapped. Now, how do we know how long an asset is depreciated? Do we put values from the belly or what is the phase? Well, after all, no one can know exactly how long a machine will work. There are guidelines that set the so-called normal depreciation periods used in the tax calculation, but more important than these guides is the business experience of entrepreneurs and accountants who estimate together how long they can use an asset in good conditions. This explains why one company can depreciate a vehicle in 5 years and another company depreciates it in 3 years. When we compare ourselves with other competitors, we must also consider this amortization because it greatly influences the financial results. We also have an exception to the depreciation of long-term assets. Lands will not be depreciated. They maintain their constant value over time and the gross book value is equal to the net book value. Now, let's look at the two types of amortization. We have linear and accelerated amortization. Linear amortization is simple. The gross book value of the depreciated asset is divided by the number of months for which it is estimated to be used, and the resulting amount is the monthly amortization expense. Noted in P&L. As you already know, in our calculation, the linear depreciation is 50 USD per month respectively, 600 USD per year. Accelerated amortization means including in P&L a higher amortization for the first years of use of an asset. Let's say that in the first year, half of the value of the vehicle will be depreciated, and in the next 4 years the remaining value. Here is an example in the table. The question is: which method is better, accelerated or linear? The answer is that no one is better than the other. There are advantages and disadvantages. When choosing a method, we should ask ourselves how correctly it reflects the way the asset is used in the business. If an asset is more productive in the first part of its life (for example, a silver or other rare metal mine is more productive in the first years) and generates more income during this period, we will opt for accelerated amortization. If the contribution of the asset to the income is constant over the entire period of use, we'll use linear amortization. In general, companies use linear amortization because it is easier to calculate and easier to track. There are strategies in which certain directors chose linear amortization, although the most appropriate was accelerated, just to show shareholders that the investments has improved profit. Others chose accelerated amortization in order to have a negative profit and no longer pay profit tax. You can choose exactly what suits you. Amortization and depreciation is a calculation that can be manipulated according to different objectives and interests. And that being said, see you in the next lesson where we discuss about accounting principles. See you there. 9. What is a Cash Flow Statement?: Hello and welcome to this new lesson! In this lesson, I want to talk to you about what is a cash flow statement and why do we need it? Cash flow is the cash that comes in and goes out of business in any given time frame. All of that cash is tracked in one of three places: Cash flow from operations, from investing and financing. Cash is actual money that has come into your business. For example, if you send an invoice to a client, the amount due is not considered cash until you are paid. Once you receive payment, that becomes part of your cash flow. Until then, it's known as accounts receivable and not cash in hand. If more cash comes into your business than goes out in a time period, you have positive cash flow. If more money goes out than comes in during a certain period, you have negative cash flow. The cash flow statement measures how well a company manages its cash position, meaning how well the company generates cash to pay its debt obligations and fund its operating expenses. The cash flow statement complements the balance sheet and income statement and is a mandatory part of the company's financial reports. Cash flow and profit are not the same thing. Profit is your business' financial gain and is calculated by subtracting your cost and expenses from your revenue. What's left is your profit. The formula for profit is: revenue minus COGS minus expenses equal profit. Unlike profit, cash flow is all the cash coming in and going out of your business. While this does include the cost of goods and expenses, cash flow also includes transactions like credit card payments, loan payments, payroll, sales tax liabilities and owner's draws. So it's possible to be profitable and have negative cash flow at the same time. Here is an example. Let's say you calculate your profit, and your numbers are: revenue one hundred K (100.000$), cost of goods sold 30K (30.000$), expenses 40K (40.000$), and profit thirty thousand dollars. You have profit, but what if you also have to pay your loans, your sales tax payment and pay yourself? In this case we will have profit 30K (30.000$), loan payment 15K (15.000$), sales tax payment 10K (10.000$), owner's draw 10K (10.000$) And, the cash flow would be minus five thousand dollars. Even though you are profitable, you do not have enough cash flow to make all your other payments. It's important to memorize this difference between cash flow and profit. Now, why do we need a cash flow statement? Everyone gets excited about having a profit, but having positive cash flow is just as important. Without healthy cash flow, your business can be severely impacted. Without cash, your business won't run, your employees become cranky and suppliers stop shipping you, and believe it or not, you can run out of cash while your business is very profitable. Keeping up with debt. When you borrow money to buy buildings, equipment and inventory, you essentially use future cash flow to make your purchases. You need positive cash flow to pay your debt. Companies commonly have long term loans and short term credit accounts with vendors. Each loan requires monthly payments. The obligation to make these payments on an ongoing basis restricts your free cash flow, which is money available to invest in growing your business. Good cash flow increases opportunity. Along with debt management, strong cash flow provides you with opportunities to invest in growth. Building new locations, investing in research and development, renovating infrastructure, improving technology, providing more training and purchasing more assets and inventory are among the ways your business can grow and improve with strong positive cash flow. Getting to a position of excess cash flow helps your company operate in a strategic, proactive way rather than reactive, defensive way. A cash flow statement tells you where the money went. A profit and loss statement says nothing about principal payments you make to the bank. You could have reasonably good profits, but the amount of money you pay your bank every month could be putting you out of business. Cash flow statement tells you where you spent your money. Cash flow statements help with financing decisions. Buying capital equipment uses cash. Growing capacity in your company uses cash. Adding inventory uses cash. Adding customers uses cash. Understanding where your cash goes and how you will provide more cash when you need it are key parts of running a successful company. Profitable businesses can go bankrupt. It's important to understand cash flow versus profit. Just because customers have ordered lots of product from you doesn't mean you can pay your bills. For example, you might sell one hundred K (100.000$) worth of products on credit, offering your customers 60 days terms. However, you might have ordered 70K (70.000$) worth of supplies to make your products for that order, and you must pay your suppliers within 30 days. If you also have 50K (50.000$) worth of rent, phones, insurance, interest payments, payroll and other expenses due in less than 60 days, you now won't have enough money to pay your bills (unless you have cash reserves of credit lines). Even if you can eventually pay your bills by asking creditors for more time, poor cash flow might eventually result in your losing vendors, suppliers and lenders, which can severely damage your business. Now, let's see what isn't shown on a cash flow statement. As you already know, the cash flow statement shows the cash that comes in and goes out of your business in any given time frame. Total revenue, total costs and total expenses are parts of the statement. And total assets, total liabilities and equity are parts of the balance sheet. It's important to understand the difference between these three statements. The balance sheet shows us the worth of the business. The P&L statement shows us the profitability of the business and the cash flow statement shows us the inflows and outflows of cash. So it's important to understand these differences. In the next video, I will explain the structure of the cash flow statement and terms used. See you there. 10. The Structure of the Cash Flow Statement and Terms Used: Welcome back! In this lesson, we will talk about the structure of the cash flow statement and terms used. There are two components to cash flow: inflow and outflow. Inflow is the cash that comes into your business, and outflow is the cash that goes out of your business. The cash flow statement is divided into three sections: cash flow from operating activities, cash flow from investing activities and from financing activities. Collectively, all three sections provide a picture of where the company's cash comes from, how it's spent, and the net change in cash resulting from the firm's activities during a given accounting period. Here we have an example. There are two methods of calculating cash flow: the direct and the indirect method. In the direct method, a company records all transactions on a cash basis and displays the information on the cash flow statement using actual cash inflows and outflows during the accounting period. Now, let's define each term used in the cash flow statement. The first section of a cash flow statement shows your CFO (cash flow from operations). Cash flow from operations is money the comes in and out of your business through your day-to-day operations. This includes receipts from sales of goods and services, purchasing inventory, paying salaries, rent payments, interest payments, any other type of operating expenses. If it relates to your daily business activities, its operating cash flow. Cash flow from operations is important because it indicates if a company can maintain and grow its operations without secondary revenue sources from investing and financing. Essentially, it tells you if your business model is sustainable or not. Also, it reflects how much cash is generated from a company's products or services. Next, cash flow from investing is money that comes in and out of your business related to investments you make in your business. Investing activities include the purchase and sale of long term assets (like property, vehicles, buildings and equipment), the purchase and sale of securities like stocks and bonds. Investing cash flow helps you understand how much money you're putting into your future growth. Since investing activities have to do with long term assets, companies that spend a lot in investing activities are generally considered to be growing companies who are securing their ability to generate revenue. Usually, cash changes from investing are a cash-out item because cash is used to buy new equipment and buildings. However, when a company divests an asset, the transaction is considered cash-in for calculating cash from investing. Next, we have cash flow from financing. Cash flow from financing is money that comes in and out of your business related to financing transactions from creditors or owners. In other words, how your business raises money and pays it back. Financing activities include loans obtained, issuing or repurchasing stock, cash contributions from owners, repayment of loans, dividend payments. Changes in cash from financing are cash-in when capital is raised, and they are cash-out when dividends are paid. Cash flow from financing is important because it helps you see how much money comes into your business from acquiring loans or from your investors. Eventually, you want more money coming in from operating cash flow than financing cash flow because it means that your business model works. Financing cash flow also shows you how much money is going out to pay your loans, which is helpful when creating budgets. Now, we will discuss free cash flow. Free cash flow is the cash left in your business after you've paid your operating and required ongoing capital expenditures. Required capital expenditures are investments you need to make to keep your business operational, like replacing machinery and equipment, purchasing inventory and investing in research and development. Free cash flow is what you have available to allocate to things such as additional investments or payments to the owners of your business. You get to choose what to do with your free cash flow. The formula for free cash flow is: cash flow from operations minus required capital expenditures equal free cash flow. You can find your cash flow from operations on your statement of cash flows at the end of the operating activities section. It's the line called "Cash Flow from operations". To find your capital expenses, run a balance sheet report and look for the fixed assets section. Or your capital expenditures can be found on a company's cash flow statement, under "investing activities" or cash flow from investing. Those will be your capital expenditures. The decision of whether to expense or capitalize an expenditure is based on how long the benefit of that spending is expected to last. If the benefit is less than one year, it must be expensed directly on the income statement or P&L statement. If the benefit is greater than one year, it must be capitalized as an asset on the balance sheet. Let's take an example for this formula. Harry runs a donuts company. At the end of the year, he runs a statement of cash flow and has one hundred K dollars (100.000$) in operating cash flow. He then runs a balance sheet and determines that his capital expenditures, which include a new donut machine and espresso machine, are sixty K dollars (60.000$). Harry has forty K dollars (40.000$) in free cash flow. He can now decide if he wants to use that money to make additional investments in his business (which is CAPEX), take out as an owner's draw, or spend it on something else. So it's a simple term, right? Next, we have the indirect method of the cash flow statement. With the indirect method, cash flow from operating activities is calculated by first taking the net income off of a company's income statement. Because a company's income statement is prepared on an accrual basis, revenue is only recognized when it is earned and not when it is received. The indirect method also makes adjustments to add back non-operating activities that do not affect a company's operating cash flow. For example, depreciation or amortization is not really a cash expense. It is an amount that is deducted from the total value of an asset that has previously been accounted for. That is why it is added back into net sales for calculating cash flow. Self-financing capacity represents the operational cash flow generated by a business, without it being influenced by the efficiency with which receivables, stocks, suppliers are tracked. Self-financing capacity is the sum between net profit and amortization. And we have a new term. Working capital. Working capital is the difference between a company's current assets, such as cash, accounts receivable (customers unpaid bills) and inventories of raw materials and finished goods, and its current liabilities, such as accounts payable. Working capital is a measure of a company's liquidity, operational efficiency and its short term financial health. If a company has substantial positive working capital, then it should have the potential to invest and grow. If a company's current assets do not exceed its current liabilities, then it may have trouble growing or paying back creditors or even go bankrupt. Excellent. Now, you know the terms and the structure of the cash flow statement. Let's move on to the next video where we build a cash flow statement with our donuts company. 11. Building & Analyzing a Cash Flow Statement: Hello and welcome to this new lesson! In this lesson, we will build and analyze a cash flow statement. From time to time, I will define the terms very simply to remind you what each one means. So let's build together a cash flow statement! We will take again the example of a company that sells donuts. The first time, we will use the direct method of calculating cash flow. Under each section, the statement of cash flows shows the increases or decreases for various sources of cash flow. Then, it totals the net cash provided to your business by each type of cash flow. I will complete the table from top to bottom, starting with cash flow from operations. Cash flow from operations is money the comes in and out of your business to your day-to-day operations. CFO includes receipts from sales of goods and services, paying salaries, rent, payments, etc. Remember that, if it relates to your daily business activities, it's operating cash flow. We will use the numbers from profit and loss statement. From here. Why? Because we received the money on the spot. When someone buys our donuts, he will pay on the spot. So our numbers would be equal with the numbers from P&L. Therefore, in the cash flow from operations, we will have one hundren K (100.000$) received from sales of goods, payment for goods is 30K (30.000$), rent payment five K (5.000$), paying salaries 30K (30.000$), payment for the accountant is one thousand dollars, payment of utilities is three k (3.000$), business travel one k (1.000$) and interest payment is five K (5.000$). Total operational payments would be seventy five thousand dollars. And the cash flow from operations is the difference between receipts from sales of goods and total operational payments. And is twenty five thousand dollars. Not bad at all. Next, we have cash flow from investing. CFI is money that comes in and out of your business related to investments you make in your business. CFI includes the purchase and sale of long term assets like property, vehicles, etc.. And the purchase and sale of securities like stocks and bonds. According to the balance sheet, if you remember this table, of our donuts company, we have some long term assets. Machinery, property and vehicle. So machinery is minus 10 k (-10.000$). The property is minus 15 K (-15.000$) and a vehicle, which we paid three thousand. The total cash flow from investing would be minus twenty-eight thousand dollars. Every amount contains minus because we paid for them in January 2020. So we have cash-out from our business. There are months when you invest money in long term assets and months when you have nothing to put in the table. In the table, enter the amounts paid for various activities or assets. In our example, if we have investments only in January, in the rest of the months I won't note anything in the investing or financing section. Finally, cash flow from financing (CFF). CFF is money that comes in and out of business related to financing transactions from creditors or owners. Financing activities include loans obtained, cash contributions from owners, repayment of loans, dividend payments, etc. According to the balance sheet of our donuts company, we have owner contribution which is seven k (7.000$). Business loan 20K (20.000$), credit card which is 10 K, And business credit which is fifteen thousand dollars. Total cash flow from financing would be fifty two thousand dollars. All these loans appear just once in the cash flow in January 2020 because we only once receive these amounts of money. We don't get 20K (20.000$) or 20 thousand dollars from the bank every month. Do we? Next is cash at the beginning of period or how much cash you started with. Let's assume that is our first month on the market. So we have zero. The net cash flow is the sum between CFO, CFI and CFF. And is forty-nine thousand dollars. And finally the cash at the end of the period or how much cash you ended with. Is forty-nine thousand dollars. It's not bad at all. If it's a positive number, you had an increase in cash or positive cash flow. If it's a negative number, you had a decrease in cash or negative cash flow. The ideal case is to make more money from your CFO rather than CFF because it means that your business model works. If your business lives only with loans from banks, one day the loans will end, so will the business. In our case is very good because in January 2020, we made some aggressive investments, as you can see here. But then we will make money with them. We will recover our money and pay our debts. Excellent. Now let's build a cash flow statement with the indirect method. With the indirect method, cash flow from operating activities is calculated by first taking the net income off of a company's P&L statement. Our net profit according to the P&L statement is twenty four thousand dollars. Amortization we don't have, so zero. Self-financing capacity would be twenty-four thousand dollars. As I said in the last video, self-financing capacity represents the operational cash flow generated by a business without it being influenced by the efficiency with which receivable, stock, suppliers are tracked. Next, we have stocks or inventories. Our inventory is minus five K (-5.000$). Why minus? Because we've already paid for the inventories. You can take inventories from balance sheet. Receivable we don't have because we receive money on the spot. And we don't buy on credit from the supplier. So zero and zero. Other debts we have, for example, five thousand dollars interest payment and one thousand dollars taxes. So we have six k (6.000$). The working capital would be one k (1.000$) and the CFO would be twenty-five thousand dollars. The sum has to be the same as CFO from the direct method. Twenty five and twenty five. The other half of the table is identical to the direct method. Same CFI, CFF and cash at the end of the period. So simply, take the numbers. And from financing. Excellent. The main difference between these two methods is the mode of how it is CFO calculated. But it's easy, right? You could use the direct method because it's easier to follow and built. By studying the cash flow statement, an investor can get a clear picture of how much cash a company generates and gain a solid understanding of the financial well-being of a company. And that's it! It's so simple to create and monitor a cash flow statement. It's your turn to create one. Let's do it! 12. Accounting Principles P&L: Hello and welcome to this new lesson! In this lesson, we will discuss the accounting principle from P&L. It is important to understand that the certainties in your pocket are not the same as the certainties in your accounting. The profit of a period (and we can calculate the profit monthly, quarterly or annually) does not mean the money with which you remained in your pocket or in the bank account at the end of that period, as a result of business activities. When we talk about P&L, we refer to a document in which the results of a business are calculated over a period of time, and these results are calculated taking into account certain rules and principles. So let's move on to the principle number 1 of P&L. The first rule when it comes to financial reports is very simple: In a company's financial reports, numbers refer to money. Thus, I introduce the first principle of P&L, namely money measurement concept. In P&L, we will see measured and counted only the transactions to which we can assign a monetary value. What does this means? To show something in P&L, we need a document, whether it is a document registered document (for example invoice, receipt, payment order or contract) or it is a calculation made by a professional who uses professional techniques and reasoning to set a value. An example of professional reasoning and technique would be: let's say we buy a building and an appraiser determines the value of a building (and we put that value in P&L), or maybe a financial analyst estimates expenses and we put those expenses in P&L. It is important to note that the financial statements reflect only values that can be measured objectively. That is, we need an invoice, receipt, contract, etc. You will need these to pass something in P&L. Please review these principles after viewing the P&L and balance sheet section of the course. I'm sure you'll understand better. The second principle in P&L is the principle of business as a separate entity or entity concept. Invoices, contracts, receipts must be written on the company and not on the name of the owner because this tells us the principle: the pocket of the business is not the same as the personal pocket. A purchase made by you as an individual does not mean a purchase made by your company. Let's take an example. We have a donut company. If I buy a bag to carry donuts, it's a business expense. But if the bag will always be used on weekends to transport things to a family barbecue, then it is a personal expense and should not appear in the P&L. If you come with an amount of money at the beginning of the business and make some various investments in the company, that money is no longer yours. Represents the initial capital of the company. Of course, you can take them out whenever you want, but even so, you have to make a decision in writing to record the reduction of capital in accounting and trade register. It is an important principle to remember because I have seen many small business owners tangling their pockets with each other. They take some money from their businesses to make some personal expenses and yet they say it's nothing serious. Until the tax authorities knock on the door and do some awkward analysis. But now you know the principle and you won't make this mistake. Let's move on to the next principle. The principle of accruals or matching concept. The principle tells us that income appears in P&L when the sale takes place (it can be the delivery of the good or the provision of the service) regardless of when the collection takes place. And the expense appears in P&L when something is consumed to obtain that income, regardless of when it happens to purchase of the good or service, and regardless of when its payment takes place. Let's take an example to better understand. We buy a stock of 500 donuts for January, but we only sell 300 donuts this month. It wouldn't be fair to put the cost of the 500 donuts in P&L if we only sold 300, right? Therefore, we'll have the income for those 300 donuts and the cost of goods sold or COGS also for 300 donuts. And this is important! In cash flow, we will note the payment for 500 donuts because in that report we have the receipts and payments. That's why I suggest you review this lesson after viewing the entire course. Let's take the example of rent. The rent appears in the P&L of the month in which it was consumed, regardless of when the rent is paid, one month before or on credit after a few months. It's February, but we didn't pay the rent for January. Even if we didn't pay it, the rent for January will still appear in P&L. Instead, we will have payments in cash flow from operations for when we pay the rent arrears. Maybe we'll pay it in February and in cash flow for February, we will note "January rent payment". Is simple, right? But if you don't understand, don't hesitate to contact me on the platform or on social media, I will help you. And these were the principles of P&L. They are quite easy. Now let's move on to the next lesson in which we discuss the accounting principles in the balance sheet. 13. Accounting Principles Balance Sheet: Hello and welcome to this new lesson! In this lesson, we will discuss the balance sheet accounting principles. The principles are very simple and easy to understand. So let's get started. The first accounting principle is consistency concept. This principle says that methods and rules must be applied consistently from one period to another, thus ensuring that the information is comparable over time. Similar elements should be treated similarly, and once a way of presenting them is chosen, it should be applied over time. The principle is simple. We must apply the same method once chosen. Next. Here are 2 very interesting principles. The principle of historical cost and the principle of prudence. The principle of historical cost tells us that, in the financial statements, all the elements are presented at the value they had at the time the transaction took place, namely at historical cost. The prudence principle tells us to be cautious and circumspect when it comes to valuing assets and being very careful not to anticipate future gains. Let's go back to the example with the 500 donuts. Let's say we pay 1 dollar per donut, so 500 dollars for the whole stock. The value of 500 dollars is included in the balance sheet, even if the sale price of the stock is 1.5 (1.500$) dollars. The purchase price is noted, not the sale price. More correctly, the balance sheet will present the stock of donuts at its historical value, namely at 500 USD. We must also pay attention to the fact that, even if the value of donuts had suddenly increased to 100k USD (100.000$) due to a crisis on the food market, from an accounting point of view, it would have remained in the financial statements with the initial value, namely 500 USD. The same is true for fixed assets such as land, buildings, vehicles, etc.. It is true that, unlike stocks, they depreciate, their value decreases over time, but their historical cost is depreciated and not any other value. Very important to understand. Regardless of when a transaction took place, a month ago or a year ago, we'll keep the cost from the time of purchase. The prudence principle tells us to be skeptical and not present things pinker than they really are. We present the stock exactly at the purchase price. We cannot overestimate the asset. Moreover, the principle of prudence is what obliges us to make provisions if we find that the value of the asset, that means our donuts, would fall below the historical cost. That is, a donut is no longer worth 1 dollar. Thus, I introduce a new term. Provisions. Let's say that by a miracle 500 donuts from our stock of 500 would be damaged, that is the whole stock. What we can do in this situation because we have already paid for everything and the P&L and the balance sheet are made. Well, we make a provision. It is clear that we won't sell the donuts for 3 USD as we said at the beginning, but maybe we can sell them for 0.5$ a piece to minimize losses. So we will collect 250 USD. In short, we paid 500 dollars for the stock, but we estimate that will only collect 250 USD as a result of the disaster, so we estimate a loss of 250 USD. In the month of the disaster, we estimated an additional expense. We'll present this loss in P&L in the month of the disaster under the name of "provisions expenses" and the related amount. At the same time, the value of the donut stock will be lower, the asset will decrease in your list of current assets and next to the stock you will note only 250 USD. Now let's define the provisions. These are simple estimates of losses that are taken into account when calculating the results of a period or when establishing the value of an asset at a given time. Provisions are calculated only if events occur that reduce the value of an asset (such as floods, earthquakes and other natural disasters). Provisions estimate a decrease in the value of the asset when, for various reason, its value is below historical cost. As in our example, we took the donuts for 500 USD, but due to a disaster, the donuts are now worth 250 USD and we have a loss of 250 which will be noted in P&L under the name of "provisioning expenses". It also applies to fixed assets if the property decreases in value. You don't have to put aside or pay 250 somewhere. You have already paid the 500 USD on stock, only that its value has dropped sharply. Provisions are pen expenses. However, if you could sell the donuts with the purchase price, that means 1 USD per donut, there would be no need to enter provisions in the table. If, for example, you also have receivables to collect from a client and that client goes bankrupt and can no longer pay, we'll present the respective receivable as a provision in P&L and the profit will decrease in that period. But in business we take risks, don't we? Finally, a final principle is the going concern concept. He says that all the figures in the financial statements are calculated starting from the premise that the business will continue its activity in the near future, that it won't be in liquidation and will not significantly reduce its activity. The principle is simple. If we do not continue our activity, all the goods will appear at the liquidation value, the value at which it would be sold if the donut shop closed. In some companies, it happens that a good is no longer worth anything in the conditions of liquidation and money may be needed for disassembly, demolition and others. And these are the principles used in accounting. I recommend you review them a few times because they are very important. See you in the next lesson. 14. Final Thoughts!: Hello, guys! We have reached the last lesson of this course. I want to congratulate you for the perseverance and seriousness you have shown. I know it wasn't easy for you to understand all terms, but I'm sure that you will watch and watch again the videos until you build a P&L with closing eyes. Anyway, you did a very good job. Now, I want to briefly recap the financial statements I discussed in this course to be much clearer to you. A profit and loss statement, also known as an income statement, is a financial report that displays your total income, total costs, total expenses and net profit for any given time period. It shows if your business is profitable and if your business model is sustainable. A balance sheet shows your total assets, total liabilities and equity at any point in time. It can also be referred to as a statement of net worth or a statement of financial position. Cash flow is the cash that comes in and goes out of business in any given time frame. All of that cash is tracked in one of three places: operations (it's called cash flow from operations or CFO), investing (called cash flow from investing or CFI), and financing (cash flow from financing or CFF). It's important to understand the difference between these three statements. The balance sheet shows us the worth of the business. The P&L statement shows us the profitability of the business and the cash flow statement shows us the inflows and outflows of cash, of course, in our business. Another important lesson from this course is profit doesn't mean cash! You could have profit and negative cash flow (which means no cash). Remember the example when you have 30k dollars profit, but you have to pay yourself and some loans and at the end, you have minus five K (-5.000$) in cash. If you see a profit on your report, don't assume that all that money is available for you to spend! Now, what do you have to do now? You have to learn all the terms used in all statements, starting with P&L statement because it is the easiest statement. Then learn balance sheet and cash flow statement. Download the resources because it will help you a lot! After you know the terms, you could build your own financial statements. You will see that it's not so hard. And finally, practice, practice and repeat the process! Just watching this course doesn't make you an expert in financial statements. You have to practice a lot. That's the secret to understanding financial statements, practice. That was all for this course, guys. Thank you for following me, and I congratulate you again for the seriousness and perseverance you have shown. You are the best. I really hope you found this course valuable, but either way, please leave a review and share your experience. I only wish you well with your financial statements. Have a great day!