The Complete Introductory Course To Finance & Accounting | Chris Benjamin | Skillshare

The Complete Introductory Course To Finance & Accounting

Chris Benjamin, Instructor, MBA and CFO

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51 Lessons (6h 35m)
    • 1. 001FAFSU Promo July2019

      1:59
    • 2. Introduction Course Intro

      7:57
    • 3. Accounting 101 Terminology

      17:23
    • 4. Accounting 101 Debits and Credits

      5:37
    • 5. Accounting 101 Assets

      6:43
    • 6. Accounting 101 Liabilities

      7:29
    • 7. Accounting 101 Equity Section

      20:01
    • 8. Accounting 101 Expenses

      8:29
    • 9. Accounting 101 Revenue & COGS

      8:46
    • 10. Accounting For Fixed and Intang Assets

      16:02
    • 11. Cost Acctg and Inventory Intro to Cost Accounting

      6:47
    • 12. Cost Acctg and Inventory Direct Labor

      7:09
    • 13. Cost Acctg and Inventory Direct Materials

      6:07
    • 14. Cost Acctg and Inventory Overhead and Indirect Costs

      8:02
    • 15. Cost Acctg and Inventory Inventory Accounting

      12:56
    • 16. Fin Stmt Prep Balance Sheet Preparation

      8:07
    • 17. Fin Stmt Prep Income Statement Preparation

      6:37
    • 18. Fin Stmt Prep Statement of Cash Flows

      12:28
    • 19. Fin Stmt Prep Statement of Equity Preparation

      5:29
    • 20. Analyzing Fin Stmts Balance Sheet Analysis

      11:06
    • 21. Analyzing Fin Stmts Income Statement Analysis

      11:59
    • 22. Analyzing Fin Stmts Statement of Cash Flow Analysis

      5:33
    • 23. Audited Financials How to Hire an Audit Firm

      6:47
    • 24. Audited Financials From the Auditors Perspective

      5:08
    • 25. Audited Financials Audit Process

      8:12
    • 26. Addtl Financial Reporting Waterfall Report

      5:27
    • 27. Addtl Financial Reporting Budget vs Actual

      4:19
    • 28. Addtl Financial Reporting Budget to Actual Review

      5:59
    • 29. Budgets and Forecasts Budgeting General Concepts

      8:36
    • 30. Budgets and Forecasts Assumptions

      6:25
    • 31. Budgets and Forecasts Income Statement Forecasting

      7:51
    • 32. Budgets and Forecasts Balance Sheet Forecasting

      5:42
    • 33. Budgets and Forecasts Statement of Cash Flow Forecasting

      6:06
    • 34. Budgets and Forecasts Forecast Walkthru

      11:59
    • 35. Raising Capital Raising Capital Where to Begin

      7:38
    • 36. Raising Capital Valuation

      7:52
    • 37. Raising Capital Avenues to Potential Investors

      9:09
    • 38. Raising Capital Investment Process

      7:45
    • 39. Raising Capital Presenting to Investors

      5:34
    • 40. Raising Capital Term Sheets

      4:16
    • 41. Raising Capital Post Funding

      4:18
    • 42. Exit Strategies Types of Exit Strategies

      3:36
    • 43. Exit Strategies Mergers and Acquisitions

      9:30
    • 44. Exit Strategies Management Buy Out

      6:10
    • 45. Exit Strategies Secondary Markets

      6:27
    • 46. Going Public IPO Process

      11:23
    • 47. Going Public Costs of an IPO

      5:35
    • 48. Going Public Timeline of an IPO

      7:10
    • 49. Going Public What an IPO means to the Company

      4:12
    • 50. Going Public What IPO Means to Past Investors

      5:57
    • 51. Conclusion

      3:34
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About This Class

Are You An Entrepreneur or Small Business Owner?

Does Accounting Seem Overwhelming? 

Do Numbers And Financial Reports Confuse You?

Would You Like To Learn Accounting & Finance in a Fun & Easy Way?

If You Answered "Yes" To Any Of The Above, Look No Further.  This Is The Course For You!

*** Updated June 2019 with new content! ***

Enroll today and join the 100,000+ successful students I have taught as a Top Rated instructor!

Three reasons to TAKE THIS COURSE right now:

  1. You get lifetime access to lectures, including all new lectures, assignments, quizzes and downloads I add

  2. You can ask me questions and see me respond to every single one of them thoroughly!  This is an interactive course!

  3. You will are being taught by a professional with a proven track record of success!

  4. Bonus reason: Udemy has a 30 day 100% no questions asked money back guarantee!

Recent review:

"Excellent course!I was looking for an introductory course to accounting and finance as I am an investor in early stage startups, and accounting/finance always seems to be an area which is confusing for founders. Chris Benjamin definitely has used his real world experience and education to create a course which teaches entrepreneurs and startups everything they should know from the start about accounting and finance. Kudos!" - JT Lexington, Maven Capital

What Do You & I Cover In This Course?

This course teaches entrepreneurs, startups and small businesses all things business accounting and entrepreneurial finance related, A to Z.  Starting with an introduction to accounting concepts, we move into financial reports and how to create them, understand them and analyze them.  Bookkeepers, Accountants, CFO's and Business Owners alike would all benefit from this course. 

First, we learn about budgeting and forecasting.  Next we discuss growing your company, how to understand and analyze it using non conventional reports. 

After growing your company, we talk about raising capital and what is involved and avenues you can take.  One section is devoted to the initial public offering process and the timing, costs and best business practices involved.

Last, we discuss exit strategies and how to give your investors and yourself a payoff for your hard work.

This course is truly a start to finish of accounting and finance.  At over 12 hours long, I wanted to make sure you will feel empowered and educated after taking the course. 

I Will Help You Throughout The Course!

At any point during the course if you are confused or need clarification, send me a message! I'm here to help YOU the student, and I love interacting with you.  I've been in accounting & finance over 20 years and can most likely answer your question. 

I have also included a copy of my ebook "Fund Your Startup by Chris Benjamin" which you will find as a download in the last lecture.  Learn your options for funding, where to find investors, how to wow them, and lastly the must do steps to successful funding!

*** JOIN NOW AND LEARN FINANCE & ACCOUNTING EASILY FROM AN ACCOUNTING EXPERT ***

About The Instructor

Chris Benjamin, MBA & CFO is a seasoned professional with over 20 years experience in accounting and finance.  Having spent the first 10 years of my career in corporate settings with both large and small companies, I learned a lot about the accounting process, managing accounting departments, financial reporting, external reporting to board of directors and the Securities and Exchange Commission, and working with external auditors.  

The following 10+ years I decided to go into CFO Consulting, working with growing companies and bringing CFO level experience to companies.  I help implement proper best business practices in accounting and finance, consult on implementation of accounting systems, implementing accounting procedures, while also still fulfilling the CFO roll for many of my clients which includes financial reporting, auditing, working with investors, financial analysis and much more.  

Thank you for signing up for this course. I look forward to being your instructor for this course and many more!

Chris Benjamin, Instructor, CFO & MBA

Transcripts

1. 001FAFSU Promo July2019: you're an entrepreneur or small business owner. Does accounting seem overwhelming? Do numbers and financial reports confuse you? Would you like to learn accounting and finance in a fun and easy way? If you answered yes to any of the above? Look no further. This is the course for you. Welcome to introduction to Finance and accounting. My name is Chris Benjamin, and I'll be your instructor in this course. I'm a professional accounting and finance expert. I currently work is a chief financial officer or CFO Ondas. Well, I've bean an online instructor since 2013. In this course, we learn all of the basics and fundamentals of accounting and finance. This course teaches entrepreneurs, startups and small businesses everything you need to know about accounting and entrepreneurial finance from start to finish. First, we start with an introduction to accounting concepts. Then we move into financial reports in how to create them, understand them and analyze them. Next we learn about budgeting and forecasting. Afterwards, we discuss growing your company how to understand and analyse it. Using non conventional reports after growing or company, we talk about raising capital and what is involved in avenues you can take one section is devoted to the initial public offering process in the timing, costs and best business practices involved. Last, we discuss exit strategies and how to give your investors in yourself a payoff for your hard work. This course is truly a start to finish of learning, accounting and finance. But over 12 hours long, I wanted to make sure you will feel empowered and educated after taking the course at any point during the course. If you're confused or need clarification, send me a message. I'm here to help you. The student and I love interacting with you. I've bean in accounting and finance over 20 years and can most likely answer your question . You've come to the right place. I encourage you to go ahead and sign up. Today. I look forward to seeing you in class. Be sure to sign up today. 2. Introduction Course Intro: Hi, everyone. My name is Chris Benjamin. Thanks. First of all, for taking this course, I'm looking forward to teaching you all about accounting and finance for start ups and small businesses. Of course, like this, I've been meaning to put together for a long time. I get asked a lot of questions about the proper kind of procedures. Best business practices, what to do, just general questions. So I wanted to get it out there and provide entrepreneurs and start up companies with the information you need to successfully run your business and grow it over time. So first of all, just a little bit about me and what I do and who I am and why you want to listen to me. Talk about accounting and finance. First of all, I have, ah, be an undergrad in accounting and finance from the University of Washington Research University of Fraser Valley in Vancouver, British Columbia. I'm a master's degree then from the University of Washington in Seattle. I'm over 15 years experience in accounting and finance and up to the level of CFO worked with all kinds of companies, private, public, different locations, different industries. So I've seen a lot and been exposed to a lot and can bring all that knowledge to, of course like this and teach you how to best go about the accounting and finance procedures for your company. So the last six years I've spent as the rogue CFO consulting. So I had my own entrepreneurial visions, and I didn't want to just work a corporate 9 to 5 job my whole life. So it came to a point where I decided I could help start ups and entrepreneurs by being a CFO to them. So certainly these air companies, and maybe you can relate that don't need a full time CFO, but they could certainly benefit from the knowledge and experience that I have. So I come in on a consulting basis and help them grow their company. And the goal is to take them from very early stage all the way to publicly traded or whatever their exit strategy might be. And that's kind of the range of the course that we're gonna talk about. In my last few years, I've taken a few companies public. I worked with a lot of terrific cos we've done all kinds of aspects of accounting budgeting , financial analysis, mergers, acquisitions. We're gonna talk about all the stuff in the course. I'm really excited to teach you. You can visit my website. If you want to learn more about me and the address is there, roque CFO dot com. So first, let's just go through the course outline. What are we going to cover to Kind of give us a road map, that we're gonna talk about some goals and then we're gonna dive into the course. So first we're going talk about accounting. Wanna one? I'm kind of coming from the perspective that you're a business person. You've started this company, but you just don't necessarily know a lot about accounting. So we're gonna go through some terminology and just how accounting works. We're gonna dive into cost accounting, which focuses more on things like inventory. And if you build something of a production that you create will talk about the proper accounting for that, how costs are created and accumulated, we're gonna dive in the financial statements. That kind of your standard financial statements. Hopefully you've heard of an income statement and balance sheet. We'll talk about Those were talking about how to read them how to analyze them, how to prepare them. Um, and then it's, well, some other financial statements that you don't might not see it might not be familiar with , like statements of cash flows, statement of equity. And then there's even a few others that I think are really helpful for start ups that you really don't see often. And I think it's a shame, and we'll get into those. So you're gonna have the inside scoop on those. We'll talk about audited financial statements, getting your financials audited. What it means, why you would want to do it. How you would select an auditor continuing on. We'll talk about just those additional financial reports that you can implement or not. I think they're useful for management decision making. We'll talk about budgets and forecasts. How do you develop a budget? What's the proper best business practices for doing so? I give you a lot of samples throughout the course of what I'm talking about. There's even a few screen walk throughs of the samples just cause I really want to make sure you fully understand what it is I'm talking about. Um, I know when you're new to something a lot of times, just the the jargon and walking through it. It's a lot to absorb, so I want to walk you through in a visual sense. It will use. The white were in a lot as well to dry out some examples throughout the course. Um, then we're gonna jump ahead to raising capital, definitely a kind of a hot topic for early stage companies and start ups. Just in my experience, I've learned a lot about raising capital. Health companies do it. I think there's a lot of misinformation out there, and entrepreneurs just kind of get caught up in that. And I want to send you down the right path rather than the wrong pass. And there's so much misinformation again overwhelms the correct information. But I want to get you that correct information. We'll talk about exit strategies so the various options you have and these are things you want to plan ahead for. You might not be at that place yet, but I want you to at least know in your head that at some point you're gonna have to start planning for these and what your options are, what they mean for the company. Specifically, we'll talk about going public, so we talked about a bunch of exit strategies. But then there's a whole section devoted just to go in public again on area where there's not a lot of information out there available to people that kind of hear things. I want to get the correct information out to you about how long it takes, what's involved, who was involved, what it's gonna cost all those things. And then, lastly, we'll go through a conclusion and make sure that we met all these goals and kind of walk through this. So let's actually talk about goals really quick. First, just the course format. Um, there's video instruction along with slides next to me. For most of the course, there's a few video walk throughs, and then there's a bunch of downloadable PDFs, and I referenced those in the lectures for the most part, so it's always good to kind of download them and look at them. And then, as the mentioned samples are provided on by, provide them with PDS where appropriate. So now let's actually talk about the goal. So what are the goals of the course? We know what we're going to go through. But at the end of the day, what what if we accomplish these goals will be a success. So first it's will provide you with a basic understanding of accounting. So we get through those first few lectures. If you kind of now have a taste for accounting, how it works, debits and credits. Terrific, that's all. That's our only goal. We're not. We're not trying to turn you into super accountants. We just want to give you the basic information, understand financial reports, know how to prepare them, know how to read them. It's one thing with somebody just gives you an income statement, and if you just look at the bottom line, but now you're gonna know what goes into those different categories. How is this determined? What does it mean? Toe have variance to the budget, those types of things, mentioning budgets, being able to properly prepare a budget in a forecast? There's again a lot of wrong ways to do it and only few correct ways to do it. So I'm gonna walk you through the correct way to do it that I like to do it, and again I provide your samples and we walked through it in a video. I want you to understand the process of raising capital, different options you have available to you what's best for your company. Think this through and no, realistically, what it's gonna cost in terms of time, in terms of money to actually raise capital. And then, lastly, we'll fast forward to some exit so math methods to cash outs. Once you have investors, how are they gonna liquidate? What's their liquidating event, where they can then cash in their investment? They invested a 1,000,000. How are they going to get five million out? What does it take? So before we start just a few more points and then we'll dive into accounting 101 So feel free to email me with any questions used the discussion. Go to my website, whatever. Whatever the case might be. Definitely Don't be shy about asking questions. I'm happy to answer them. Relax, absorb the information. If something just seems overwhelming, you don't quite understand it. I'd encourage you to re review the lecture. Just watch it again a lot of times the first time through you just trying to pick up terminology and wrap your head around. What I'm talking about the second time through it might make more sense and sink in a little bit more and then keep in mind the goal is not to become an accounting expert, and I tried to keep it at the 10,000 foot level, were possible a few times. We get into the nitty gritty details, but I always try to remind you at that point as well if you don't fully understand what I'm talking about, not toe worry, just kind of grass. The concept. You don't need to know the specifics. Um, you know your goal and taking this course again is that's kind of an introductory lesson to accounting and finance for start ups, and we're covering so much material, which I'm really excited about, but also, I don't want you to be overwhelmed by it. So with that, we're gonna start the course. I'm really looking forward to it, and we're going to start off with accounting one. A one in the next section 3. Accounting 101 Terminology: in today's lecture, the very 1st 1 we're just gonna learn some basic terminology that you need to know to start down the path of learning more about accounting and finance for small businesses and start ups. You'll hear these terms used, whether it's your first year in accounting or whether you've been around for 10 years. In your CFO, Uh, these terms never go away. So it's a good, fundamental education on the terminology that we're gonna throw around often throughout the entire course. Well sourced set the groundwork. So the first thing we're gonna talk about is the standard financial reports that you'll see in accounting and that you can then use to understand your business better. Now, each of these financial reports were actually going to get into later in other lecture specifically so that I spent too much time like learning about the reports. I'm just gonna give you the high level fundamentals and tell you a little bit about the report and what it does. So you have some again, an idea when we get to it. So first is a balance sheet. The first thing I want you to know about a balance sheet is that it's like a snapshot. It's as of a specific period in time. So as of 12 31 here's Here's where we stood and what the balance sheet reflects is what you owned, what you owe and what's left over. And that's what belongs to the owners of the company. Uh, we're gonna get into assets liabilities. What? Not on the next slide, I believe. But for now, just know that it represents what you own and what you owe. And then there's some residual amount that belongs to owners. The second report that income statement and we're going to use the terms, Income statement, profit and loss, p and l statement of operations. All these air the same report. They just have different terms pitting on where you are in the world. Different people just like to use different terms. I typically will say P and L, which is profit loss or income statement. I use them interchangeably. The same exact report and what it represents is first of all, it's like a video. So where's the balance sheet is a picture? As of a specific period, P and L earned income statement is a video of a period of time. So say January 1st to December 31st. Here's all the activity that happened, and here it is in one number. So here's how my host, how many widgets we sold between January 30 January 1st and December 31st and maybe it's AH 100 widgets representatives, some sort of revenue number, maybe their dollar each. They have $100 in revenue before we get to fry throughout the term widget. So which it's a generic term that's used to represent an item that you sell. So rather than try to use a specific example like pretend we sell cell phones or video cameras, or would we just keep it simple and say, a widget? It's a generic term, and that way you can think of a widget as of whatever it is that you sell on. Whether that's service or a product itself, a widget represents some something that we sell. Uh, the next financial report that you'll often see is the statement of cash flows. Now what the statement of cash flows does is it takes all the activity for the period. Again, it's this one's like a video as well, so it reflects a period of time. It takes all that activity and shows you where your cash win. So where to cash come into the company? Where did it go out. It starts with the beginning balance. Here's all the things that happened and here's where we ended up. The reason you have a report like this is that on your balance sheets of thing back to the balance sheet in the section of what you own. One of those line items is cash you don't necessary. No, you just see an ending balance for cash. Remember, the balance sheet is a snapshot. So at the end of the year, we had $1 million in cash. Well, how do we get there like what happened during the past year to get us there? And that's what the statement of cash flow tells us. And again, we'll dig into it and really look at the specifics of how that works and how it can tile these reports together on the last report I have listed here is a statement of equity. It's not gonna be a primary financial statement. You might not even see it. A lot of companies don't even generate it, but I want to put it out there as you grow into a larger company will be something that you'll probably get more involved in, not a difficult financial statement and what it is is. It's really a detailed breakdown of the equity section of your balance sheet, and the equity section is what's left over what the owners have a claim to. So if those assets minus those liabilities or what you own and what you owe the Delta is your statement of equity on the balance sheet, it's in a summary format. And then on the statement of Equity Report, it's broken out into more specifics, and we'll look into that as well. So going back to the financial reports now let's talk about the specific sections that are on the balance sheet on the income statement and those there really are two primary financial statements we're gonna deal with in the world of accounting or fear and management that you're looking at to see how the company is doing. Sure, you look at those other financial reports like statement, a cash flow statement of equity, but balance sheet and income statement or your to kind of go to places, starting with the balance sheet. There's only three primary sections, their assets, liabilities, equity. And again, the specifically match. What you own is an asset. What you owe is a liability on what's left over is equity. Uh, so obviously the name balance sheet abound. She needs balance. So the formula is that assets. So what? Your own equals liabilities plus equity and Harold Us. Write that down and I'll show you some leads to rearrange this, that it's thought off. So we have our assets equals air liabilities, symbol to stay lives plus equity. I apologize in advance, my hand rings atrocious, and I'm gonna try to keep it to a minimum or use abbreviations so assets equals liabilities plus equity. You can also rearrange this is assets. Less liabilities equals equity. So what you own less? What you owe is what's left over. An equity is what's left over for the owners of the company and whether those are shareholders or yourself. Maybe you're the sole owner of the company. That's what's left over. Will you have claimed to, um, going to the profit and loss? Revenues and expenses are kind of the primary sections, if you will. So revenue represents again a period of time, and it's all the widgets that we sold. So we sold 100 widgets at a dollar each. We have $100 in revenue. So that's this represents the money that we've generated through the ongoing activities of the business expenses that are all the costs related to running the business. So there's gonna be some direct costs, like the cost of those widgets, like we sold them for a dollar. But maybe we paid 50 cents to buy that widget, and that's our business. We buy widgets cheap, and we sell them for a premium. That 50 cents would represent a cost that we had to incur. Things like your salary is the cost of the business. Travel expenses, marketing, payroll taxes, income taxes. All those things are expensive, so on your income statement, your profit and loss you have your revenue. You have your direct costs or your cost of goods sold is what's gonna be and again we're going to get into that more. When we get to the income statement, all your other expenses that travel the payroll bottom line will be a net income number, which is what you're will you've generated in periods to say it's a one year period and we'll try to disuse one year. It's kind of the standard example that we talk about going forward. So if I don't say it, we're gonna talk about it one year period, January 1st to December 31st so that net income represents the revenue less all your expenses and where you stood. Its mother, Mr Terminology, that you're going to hear. So going back to your balance sheet, we talked about our liabilities and what we owe, um, primary liabilities, accounts payable. So accounts payable is vendors where you've received some service. Maybe you bought some inventory. You haven't paid them yet. You have terms, so you have to pay them for 30 days. Well, that's still an obligation of your company, and it's money that you owe and yourself, as a business owner, need toe reflect that on financial statements, and that's what accounts payable this. That's money that you're you're you're gonna have to pay at some point, but you haven't yet likewise accounts receivables the opposite. It's money that people owe you, and it's an asset It's something that is of value to your company. That's going to be cash that comes into the company right now. It's not cash, but it's money that's owed to you a debit and a credit. So accounting is a double entry system. Um, debits must equal credit. And you might have heard that just after in the world, even if you're not in accounting, it's kind of a fundamental law of accounting, if you will. So debits and credits on what debits and credits mean is that for every transaction there's two sides. There's at least two entries, if not more. But the end of the day the totals of those debits and credits has to equal on. That's what keeps this formula in line like it's never gonna go out of whack as long as there's always entries on both sides, um, or on the P and L and whatnot. And again, we'll get to how those all tied together later on. But just know for now that there's debits and credits, and depending on the nature of the transaction, there'll be a debit or credit. For example, when you have an expense, it's typically a debit when you generate revenues, typically credit. We're gonna walk you through all those and how the transaction work come the next time I have one here is the cruel, and I'll actually maybe we'll just walk through one super quick to give you a taste of a debit and credit. So what in a cruel is it's like an accounts payable. It's money that you owe three. Only difference is that in accounts payable is something where you've received the invoice already. So say you, um I went to a lawyer. You're going public. You're using a lawyer. It's coming up on the Iran. They sent you a bill for November. So you enter it in your counting system. It's in accounts payable. You haven't paid it yet, but you know that money. Then December rolls through, reuse your lawyer, but haven't received your bill yet. But you're you want to get cranking on your financials for year end, and you know that you owe them say $10,000 for death. December. You just received a bill yet, so you can't technically enter the bill, because maybe it's a little bit different. Um, you want have you know their invoice number. All that type of stuff. You don't enter Bill in advance of receiving it. We do. Creating a cruel so in a cruel represents, some liability that you're gonna have. Let's just walk through will use. This is kind of our debit and credit example, if you will. Um, and we often represent debits as d r. Credits CR. I think that's fairly easy toe grasp. So for in a girl, so way occurred some legal expense. We know we're gonna have to pay it. We haven't received a bill 12 31. What do we do? Um, all this right out the entry for you since probably not off top your head. Know what it is? It's gonna be legal expense for we said 10,000 just 10 and then accrued expenses for 10. So you'll see there's a debit and credit they have to match. All of accounting is like this. You can't just have one side of an entry. There's always some other side Now it might be a situation where you have multiple debits that add up to the $10 like maybe they do accounting for you and legal, which would be weird. But they don't, um, let's just say when they did, you would have maybe accounting expense for five legal expense for five accrued expenses for 10. Again, we still have that symmetry, debits, equal credits, Um, and then where these fall is that this is the profit and loss accounts that shows up on your income statement. This is a balance sheet account, so that would show up in your liabilities. And again, your debit in your credits match. So that's an example. Both in a cruel and a debit credit. How those work. So just a taste. If you know, if this is a bit much, don't worry about it. We're gonna talk more about the specific, um, accounting reports. But just I think the key point is remember that you do have to have that balance with Devon's credits. A trial balance I have on here. Just so you know what it is, you're not necessarily going to use it a lot. It's basically a full listing of every account. So, like legal crude expenses, cash all your accounts on your chart of accounts, which is every single one of these, with the balance as of a specific dates as of urine. What was the balance in cash? How much legal expense did you have for the year, etcetera? The reason you look out is one. All the debits and all the credits have to match at the bottom, so it's a good check for that. It's difficult to get out of balance these days with computerized systems, but nonetheless, it's a good place to look. And a lot of times you'll use your trial balance to the generate financial reports. We're gonna talk more about generating reports. The easy way is you do them within your accounting system. Let's assume use like a QuickBooks. Um, all these reports are in there. You press a few buttons, you set your dates, the reports come out. Sometimes people like to customize the report so they do in Excel. And that's where trial bounce would come in handy cause you have all those balances and then you can link them to the financial reports. Just some additional terms for you. Um, and there will be at the end of this lecture, we'll get more into the specifics of accounting. So break even is basically how many widgets do I need to sell to generate zero profit. So the point where the business is self sustaining, we're not losing money. We're not making money. Just how many widgets is that? So you have that in the back of your mind, like we need to sail 10 widgets every month in order just to break even to keep this business going. And there's some formulas behind that. But you know that if you only sell nine widgets, your you're burning money that you don't have in the business. If you sell 11 you're generating profits. That's that break even point appreciation is, ah, accounting concept. What it is, it's an expense that you represent that reflects the usage of some type of assets. So pretend we have a truck truck's gonna last us 10 years, and then we figure it's gonna break down. It's gonna be outdated. Whatever I say, we bought this truck for $100,000. What depreciation does is that represents three usage of that truck, and there's different methods of depreciation that we won't get into. The typical is called straight line, where basically, you would appreciate it evenly each year, and the concept is that we bought $100,000 truck. So each year we need to represent that we use 10% of that truck, you know, 1/10 of the 10 years. So every year we would reflect $10,000 expense of depreciation, basically saying we used up 10% of this truck this year, it's now only worth 90,000. So now only worth 80,000 is to go through the various years, and that's what depreciation is. It's not an actual cash expense because you already paid for the truck. It's just too fairly reflect on your financial statements that you have this asset that's being depleted. Like after 10 years, it's not gonna be worth anything. And that's what depreciation names to dio. When you can appreciate both the fixed asset like a truck, a desk computer, you pick how many years that's useful for, or an intangible assets like a patent. How good is the patent for When does the patent expire? Trademarks. Things like that. Typically, when you talk about intangible assets, the term uses amortization instead of depreciation, exact same concept, recognizing some expense to reduce the value of that asset. Next time I have on here is gross profit. Cigars profit is your revenues less. Your direct expenses, which I'll stop using, were direct expenses. And what is shown is on the financial statements, cost of goods sold or cost of services. If you're in the service business, Acosta get sold is the direct expense for the widget. So you sell a widget for a dollar, but you paid 50 cents for that widget. So that 50 cents is is your cost of goods sold? And I think the terminology says it says it Well, it's the cost of the good that you sold. So you're gross. Profit is the $1 less than 50 cents that you paid for it. So you made 50 cent profit on that item. Gross profit falls up in the financial statements, and we look examples. You'll see it on, and then all the other expenses are below it. Travel, payroll, all those other things. Um, when you get to the very bottom line, that's net income or net profit. So gross profits up here. Net income is down here and actually have net income on here. So it's after all those other expenses, but is but all right, The next term I have on here is is the weights, pronounces ebita. Um, you'll hear it often. No. Nobody ever remembers what it stands for. If you're not in accounting, you won't remember, but it's It's used in some of the ratio, so I think it's important to know what it is. And if you can't remember what it is, you'll have a leg up on everybody else. Its earnings before income, tax, depreciation and amortization. So thinking back to depreciation we talked about, it's a non cash expense. It's just an accounting entry that used to reflect the usage of an asset. But it's not something you you necessarily did in this period. You know, you didn't hire a new person. That type of stuff, depreciation just kind of happens. Income taxes just kind of happened, like it's a responsibility of the business. But it's not something you actively do as part of your business. So what EBITA is meant for is it's to show your earnings before all these other expenses, which you don't really have control over. So you don't really have control over your income taxes. You don't have control over depreciation and amortization. Those air just expenses that happen as a result of being in business. And those numbers can be different if you have a high income tax number. You kind of wanna look at the earnings before that, because then you have this common denominator as you compared other periods. That's what EBITDA is on the last day. I have intangible asset on here already touched on it a little bit. It's all those things you can't touch, basically, So it's like patents, trademarks, copyrights, the three common ones. The easiest way to think about their an asset that you own that provides some value to the company. You know you have a patent. Um, nobody else can then build the widget the way you build it because you have a patent on it . But it's not something you get touch. You might have pizza paper that says you have a patent, but that's about it. Um, so it's an intangible asset. It's not a desk or a chair or a truck with that, that's it for terminology. We're gonna will use more terminologies. We go through the course. If it wasn't here, you know I'll explain it, and certainly as we use terms even from here, like even doll kind of reference back and just say, Hey, remember, we talked about even dot This is what it waas. It'll jog your memory, but with that, you have kind of a basic understanding of the terminology of accounting. 4. Accounting 101 Debits and Credits: so previously when I introduced you to the terminology of debits and credits, I kind of gave you a quick example with legal expenses, accrued expenses. Now we're gonna devote a little bit more time to learning about debits and credits. Just you can really wrap your mind around it because it really is. The fundamental of accounting is debits and credits to making sure that balance and understanding just just white why it is that way and how it works. So first of all, we hear so debit or DRS we represent it is the left side of the transaction. So we'll talk about the left side on the right side and the reason we do that don't coming on here on the slide. But you might have heard of a T account. So what A T account ISS is A T. And we'd write the title up here, and this is very old school accounting. Back when things were done on paper. This is how they would literally do it. You know, do this now in the computerized days, but I think it's good to kind of have a visual idea of what happens. So the left side are Dev. It's the right side of credit, so we would say left and right side, that's why. So it's the left side of a transaction regardless of what the type of account. ISS. We don't want to label this cash. It's just X y Z chart of account item assets and expenses typically fall here. So these air assets and expenses credits the right sides of transactions are gonna be your other three types of transactions revenue, liabilities and equity. Now these terms hopefully ring about. These are all balance sheet or income statement type of accounts. So asset is balance sheet circle, um, liabilities and equity or balance sheet, and then revenue and expense or profit and loss. Think again. What was our formula with assets equal liabilities plus equity assets on the left side, liabilities and equity on the right side. So that's where you get that balance revenues and expenses Kind of makes sense, doesn't it? That revenues expenses would be on opposite sides of our T account because one is money coming in, it's generating revenue. Generated expenses is money where you have to spend, you know, your salaries and whatnot. So im already mentioned before the fundamental rule of accounting as accounting there's assets or debits equals liabilities plus equity, which are credit accounts. All types of accounts can have both. So we kind of listed here on one side. That's not to say you can't have an asset that has the credit transaction happen. Things happen. Something might have an expense. And these go both ways. This is kind of the standard 95% of the time where transactions will happen. So if you have a revenue transaction, it's gonna be a credit. You have an expense is going to be a DeMott. Um, I shouldn't note. Also, this is kind of and increase or in addition to an expensive and asset. So we buy something. Cash goes up with Deva Cash, we sell something, revenue goes up, we credit revenue. So that's where things might flip Flop. Say somebody returned something now. So we sold something. We doubled it are sorry we credited revenue originally, but somebody returns it well Now we need to reduce revenue because we got a refund. We recognize that revenue already. Now we need to reduce our revenue. That would be a case where we actually debit revenue. Likewise, we would probably credit accounts receivable, which is an asset. So you flip flop that transaction. So there's kind of things that happen where you do flip flop, those debits and credits. For the most part, though, this is how things shake out. So I have some examples on here, so the company pays rent with cash. It doesn't happen often, but let's just pretend, uh, and I wrote out here your debits and credits, so rent expense. So expense is your debit cash, which is an asset is your credit. Now you're saying, Well, assets over here. Remember, though this is increased when you increase your cash, it's a debit. In this case, though, we gave out cash with paid her rent, so it's a decrease to cash. So it be Devitt expense Credit Asset example. To hear company sells a widget for cash again. Typically, it's being accounts receivable. What? Not for purposes of demonstration. So we increased our cash, which is an asset, you know, we received money for it, and we increase our revenue. We sold this widget and then just beyond what's on here. We kind of talked about what Now? If somebody returned that widget, we had to get back. Their cash would be the flip flops. So we would debit revenue. We would reduce their revenue that we would reduce our cash cause were given cash out. So that's a fairly simple debits and credits. Um, again, most computerized systems take care of this for you. So, um, I wouldn't spin your wheels too much on trying to figure out and remember. Well, you know, what do I do with this on that? Because when you enter a transaction in, say, an accounting system, let's just say QuickBooks it takes care of that for you. You know, you write a check and QuickBooks it knows to reduce your cash and increase the expense for whatever you coded as you know, salaries or rent. You know, if you write a friend check, it takes care of all that for you. And when you run a report, it's gonna reflect that transaction. But know that this is what's happening behind this behind the scenes, if you will. So it's good. At least have an understanding what's happening. Like I mentioned back in the early days, they actually had to map all this out, you would have a T account for every single cash accounts receivable, etcetera, and they all had balance. A lot of a lot of manual labor, a lot of manual work, balancing things we don't have to do these days. But hopefully haven't understanding now. Debits and credits. It'll come up time to time. As we talked through some more examples through the entire course, that all reference back, just do you remember the purpose of the debit and credit wide all ties together? 5. Accounting 101 Assets: But for the next few lectures, we're gonna get into each of the sections of the financial reports and talk more specifically about them. So we reference some early on, but today we're gonna talk about assets that so it's that balance sheet, the assets section. That's what you own. So first of all, what is an asset? Technically, besides, just something you own we have on here. It's an economic resource, both tangible. So cash, furniture, trucks, computers. So things like that an intangible trademarks, patents, copyrights You don't often see those. I shouldn't say often, but a lot of companies don't have those. They only have to sort of the tangible type assets, things that enlist on here. Things like inventory would certainly be a fixed or an asset as well. It's something you own until you sell it. And then it appears on the balance sheet. Financial reports. So assets is that first section on the balance sheet. But certainly when we get into cream, the balance sheet will really die. Vinto line by line, what assets are so? But for now, we're gonna talk about, um so within the asset category. So we have this major section assets. Now let's break it down a little bit further. So there's current assets and long term assets, current assets or sometimes called liquid assets, just cause you could turn them into cash. Neither are Kasher could be turned into cash fairly easily. So if you needed them to pay bills, you could do so. So the first current ashes is always cash, and these are fairly standard classifications of them. Sometimes you see something come up. This may be just unique to a company that not a lot of companies have. But I think the ones we talk about this kind of goes through the whole course. Anything we talk about kind of standard, um, things you'll see. And I might even touch on a few things that you don't see like research and development. Not all companies have that, but I want to put it out there nonetheless, cash and cash equivalents. So actual cash in bank accounts, cash equivalents would be things like CDs. You don't see a lot of cash equivalents these days, to be honest, sort of short term investments that you can liquidate very quickly, and I have on here short term investments because typically, companies would break that out, but they might not. So it's cash and cash equivalents, which is usually just cash and then short term investments, things like CDs, certificates of deposits, T bills, things like that where they could they could take it to the bank, cash it in that same day if they really needed to. The next kind of a current asset would be receivables accounts receivable, money that people owe you for things you've sold them. So you sell your widgets. They have 30 days to pay you. That's in accounts receivable. Um, we'll get into some of the ratios of financial analysis later on in the course. But receivables is one thing you want to manage fairly carefully because you don't want to see that building. That's money that people owe to you that you're not collecting on. Well, also, I don't know that we necessarily look at it, but in accounts receivable aging, how old are your receivables to somebody? They might only have three days to pay you, but they didn't pay you. So now they are 60 days late there, 90 days late, and as you get further out, it's less likely you're gonna collect on it. So I was encouraged companies to be fairly aggressive on collecting on their receivables, and you're turning that comfortable into cash and cash is king of the thing is, inventory is usually a current asset, and the reason is you're not buying inventory to sell it two years down the road. You're buying inventory cause you want to turn it quickly. Um, so it's all those widgets that you're buying, you know, those air your inventory until you sell them. So we we've been kind of using the example in the previous lecture where we sold a widget for Buck and we paid 50 cents for it. So our costs are 50 cents, is how it would sit in inventory and we bought 100 widgets of 50 cents. We have $50 an inventory until we sell it prepaid expenses. These are things you're paying for in advance we haven't used yet, and it's gonna be an expense. So the common one is a lawyer. You put down some type of retainer, say you put down $10,000 retainer with a lawyer, and then each month, you typically use up about $1000 worth of service. And once the retainers depleted, they'll ask you for more money. Well, this is money that you've put out, so you have to reflect the transaction. Somehow. You know, you wrote them a check for $10,000 but you didn't incur $10,000 worth of legal expense that months, A January that's gonna be spread over entire gear. So the money sits in prepaid assets. You've paid for something you haven't yet received the service for, um, and that's where it is. And then as you use it, you deplete your prepaid asset. We have expense there, used interchangeably. I needed to do represent in the legal expense on your profit and loss. So next section of assets will be long term assets. So these are things that you can't easily liquidate, Um, things that typically want to think of over one year. So we'll go through these long term investments. So say you invest in another company, lent the money, and it's not payable for two years. That's a long term asset. You have no access to that money for two years. It's a long term asset. Once it kind of eclipses that one year mark, though you would move it to current assets. But it's a long term thing that you own. Fixed assets are always classified as long term assets that 99% of the time there's always exceptions. Um, you know, you buy a computer, you buy a truck and chair, whatever it might be, that's something you bought T to generate revenue. Not directly, but it's part of the business. You need those things. Um, there things that you owned, you could certainly sell it. If you have time, you know, permit it. You could sell all your computers and use that cash. You're most likely not going to, though. So those are long term assets. They want to reflect that. It's something that the business own. And as companies grow, they accumulate assets. And you know that's one way investors will look at a company is like, How much do they own, like how much stuff accumulated? And I'm not trying to apply that you should just buy a bunch of stuff because it looks good on your balance sheet. I'm trying to imply that, you know, the larger the asset base, the more the company's worth. That's money they've invested back in the company. They're good indications of business growing. And then, lastly, we have intangible assets on here. Those air, those things, the patents, trademarks, copyrights. They're usually very long term, you know, Maybe it's like, good for 20 years, 20 year patent. I'm not sure what patents are, how long it's a normal pattern is good for, But let's just say it's good for 20 years. That's a 20 year asset them. So it's something that's gonna be used to help generate revenue in the business. You know, you have a patent on your widget. No one else could make it. It's not something you get touch, can't touch a pad, and it's just something you own. It's out there. You have a right to it. Therefore, it's an asset that you want to reflect on your balance sheet. So in general, there you go. That's the asset section. In a nutshell. If you will, certainly there can be other classifications, but I think for the most part you discuss things like cash accounts receivable, fixed assets, inventory, possibly some other long term assets. But in kind of a startup are growing business. You're not going to see too much else. So what That will move on to liability section 6. Accounting 101 Liabilities: So next we talk about liabilities, and I've kind of drawn a very simple balance sheet for us to look at since I keep referring the different sections. Um, so first of all, before we take a look at this, just, you know, what is the liability? Technically, the definition a liability is an obligation arising from a past transaction or event. So again, you, um, had some services performed legal services, you know? Oh, your lawyer, some money. But you haven't paid it yet. So that's the transaction that happened past transaction. You haven't paid for yet, but you now have an obligation to pay them. It's settled by transferring assets. That's a fancy way of saying you pay your bill so you pay your legal bill. It is no longer in accounts payable, but you've also reduced your cash appears on the balance sheet financial report. So before we get a little bit to further um, so here's our balance sheet. We have assets of $10. I didn't bother to break them out between cash And what not your liabilities. Air $5. Your equity is $5 which equals 10. So again, remember assets, equal liabilities plus equity. Anytime you look at the balance sheet, that number must equal that number. If it doesn't, something is wrong. Keep that in mind. It's a quick way to check your financial reports. And again, I mentioned that, uh, software makes it easy. You can't enter transaction without doing it properly. It won't let you. But what happens is I mentioned to Sometimes companies will print out their trial balance and generate their own financial statements. They want to make a fancier than QuickBooks congenital rate. Um, they might mismatch things. They might miss code things because now you're entering in kind of a manual process into something. So you had your numbers which tied out, but you started entering formulas and like, Oh, this is balance. She This is PML, and something gets mapped wrong. And now your balance sheets out of balance. And that's a good way, though, to check. So if you do some sort of manual thing or we're gonna talk about budgeting and forecasting , one of the final steps I always take when I budget is to make sure that my budget, its balance sheet, balances. If it doesn't, something isn't tied correctly. I'm not reflecting transactions properly. So it's easy to, um, Miss, But you at least know that something is wrong. It's a quick indicator that something is wrong and even go fix it. Um, talking just specifically now about liability is so current liabilities accounts payable Some money that you owe to people for services they perform were using the legal example. Lawyers perform the service. They've sent you a bill. In this case you've entered in your system, you have a pay to get That's in accounts payable crude wages I have on here. And we talked earlier about accrued expenses. In general, we were using the example of a legal bill where we hadn't received the bill yet. But we knew that we would get it, so that would be in a cruel for legal expense. But you might also have accrued wages, so crude wages is a situation where it's the end of the period. December 31st for example. Um, you know that you owe people through December 31st for the service they perform, but they're not gonna get paid till January 2nd. Let's just how your payroll runs, but you need to reflect on your financial statements that you, um you know, had people you put you were You owe the money for the services they perform, so you would accrue their wages, aircrew their payroll. You would reflect that expense on your balance sheet as an accrued wage, and then the expense part would fall on your P NL. And then when it gets paid the following month, we get into a little bit more tricky accounting not too difficult, but basically would reverse that. A cruel and now you would actually reflect the actual transaction that happens. So the reversal in the actual transaction kind of cancel each other out in January 2nd, and you've properly reflected the expense in as of 12 31. Don't worry too much about that part. Credit cards. A lot of companies use credit cards, so certainly liability. It's money that you're spending, but you haven't actually paid the bill. You don't pay the bill till the credit card statement comes, and maybe the statement comes at the end of the month, and you still have 30 days before it's due. So that's a liability. Um, it doesn't necessary sitting your accounts payable because kind of a unique one. In a lot of times, people want to track it. They want to see how much do I owe vendors? How much do I owe the credit card company? And that's why you would break that out. Current portion of long term debt. So again, the 12 month rule applies between distinguishing between the current liability and a long term liability. So if you had a long term debt you're paying each month and it's over five years, the last four years would be long term debt. The current one year would be a current liability. So and that's where it says the current portion of long term debts. And that's a transaction you need to kind of make each month. You need to reassess. Well, how much do we owe in the next two months? How much do we owe? Um, after that on break that up, you need to true it up on your financial reports each period, or maybe just that year, and you do that so nothing of long term liabilities. So its liabilities that air do 12 months or greater. Um, it's a long term debt. Again, you have a five year note that you're paying on equal instalments. The first year is current liabilities. Those other four would be the long term debt portion of that notes payable. So no payable long term debt could be the exact same thing. Any type of debt instrument where you owe someone money. That would be it. Um, you know, bank loans. You sign a note with a private party, maybe some of your family lunch money to start your company. It's not due for five. Maybe it's not due for five years, and there's no payments in between. Then there'd be no current portion. It only be the five, the payment that's due in five years. And it would be a long term debt mortgage loan. You don't see this a lot. And accounting, to be honest, just you know, people are buying properties anymore. You typically leads very solemn Steve by situation. But if he did, um, the mortgage, the current 12 months will be current liability. The remaining mortgage would be long term liability. With that, that's liabilities. In a nutshell. I'm not too difficult. Teoh. Wrap your hands around the most common things you're going to see, especially in the early stage company. Are those accounts payable? Accrued expenses Don't get too hung up on. I know we've talked a lot about it, but you're just It's similar to an accounts payable. It's money that you owe. You just haven't technically received the bill yet. But you want to properly reflected on your financial statements, Um, and then things like crude payroll and whatnot. That's kind of as need, a type of thing. And your accountant certainly would know how to handle that. But now, you know, if you see that, what? That ISS and you go, it should hopefully ring a bell. You see a balance sheet within a crude payroll. Okay, well, that's money that we owed. We hadn't paid it yet. And most likely especially for a crude payroll that something's gonna pay now in the near future. One other example that just comes to mind is especially in a start up environment. A lot of times, companies can't afford to pay their employees, you know, they're on a shoestring budget. You have people who are working for you, and you've made an agreement with them where we're gonna pay. You were gonna pay you everything that we owe you, but we can't pay you month a month like a normal payroll schedule. So what you would do is he would show it accrued payroll in each month, you know, $10,000. Whatever the mountainous gets added to crude payrolls to come year end, it might reflect Hey, we have $100,000 in back wages so that depending on the nature of your business, you know, whether you're a crude payroll is just a one month kind of timing difference between December 31st on January 2nd or really reflects some period of time, maybe a year, maybe two years worth of salaries, that you now oh, and assumes you get funding. You have an obligation to pay these very common in the startup world. Um and that's how it would be reflected on here because he would want over represent that expense on your profit and loss. You want to show that people are working for you, you're incurring $10,000 and payroll expense every month. It's on your profit and loss. They haven't paid it. And how you represent that on the balance sheet is it's a long term are actually sorry. The current liability in the payroll curl. So with that, that's liabilities 7. Accounting 101 Equity Section: So next we're gonna be talking about the equity section. So I left this up just for the time being. So equities down here and remember its assets minus liabilities equals equity. If we rearrange that formula, so basically represents the owners claim to the business, let's go through the slides here. Even have that on the first slide represents the claim of the assets net of liabilities. Again, there's our formula. Assets equals liabilities, plus equity or, if you re arrange, that equity equals assets minus liabilities. So you take everything that you own, you pay off everything that you owe on what's left five bucks is the equity. Um, when we get into more of the detailed equity statements, you'll see, then the details certainly on a balance sheet. Each of these is broken out, and we've talked a lot about you know what falls in assets liabilities. Now we're gonna talk about equity. What falls in there on git is broken out. So it's information about what stock is issued by the company, how much people invested in the company. The retained earnings, like money that companies made falls in the or loss falls in the equity section, so we'll work through that. And then last point here in the first slide is it's used in some of the ratio analysis, so companies will we would get the financial ratio, announced the section you'll see. But companies like to maintain a certain balance between their liabilities and their equity on the expertise. A good indicator of what, again, what the company's worth in a sentence? Not completely, but it's what the owners have a claim to. So if you have a negative equity, which certainly can happen, um, not a great thing, though, to see that as an investor. So equities comprised of several things and again you're not going to see all these each time, you're just going to see what's relevant to your company. So let's go through these so common stock. So that's fairly common in a any type of start up company, you know, issue stock to your shareholders. They give you money doesn't necessarily mean people off to hear the words stock, and I think the stock market trade ball true, that is common stock. That's that's not a lie, but you can have private stock. So, uh, when you register your company register as a corporation. For example, you author a authorized one million shares to be issued, he said. A power value and I think we talked a bit about power value a little bit here. But unless you have a 1,000,000 shares that you can give out and you determine how much money you you take in for each share, so maybe you decide in your head that shares our dollar each and when we get evaluation, that's a big That's an entire discussion coming up with how how much each shares worth. But for now, let's just say one shares worth the dollar. So her every dollar somebody invests to get one share of common stock, and that's how it's reflected on the equity section. Preferred stock is, um shares, which are have preferential rights. Usually, they cost more if the company was to issue a dividend. Often preferred shares have a state of dividend like the preferred shareholders are guaranteed a 10 cent dividend each year. If they company can't afford to pay it, they owe it when they can. Um, they have more voting rights, but the trade off is they pay more for those shares a lot of times like founders and people start, the company will have preferred shares because they want to have more control and more investment in the company. Additional paid in capital It's a little bit difficult to explain to someone, um, in terms of accounting, we'll try to keep it simple. Just do it on the white board here. What it represents is an excess that people pay above the par value of a share. So let's say we've said our par value is $1 just to make the math easy for a share of common stock. Yes, let's say you've been in business, and that's stated When you register your company, you state what that is. It's a dollar per common share, and that doesn't change. It'll show on your balance sheet. We get a $1 power value coming stock. I just see you know it's typically not a dollars typically 0.1 cent when there's a reason for that. But for the example $1 common share. So now let's say you've been a business a few years and you're going to sell some shares, your company get some for $5. You know you're not gonna always just sell them for a dollar. Companies works more, so you want to bring in $5 per share and somebody says, Yes, I'll pay $1.5 dollars per share. You can only represent on that common stock line on your balance sheet with $1. So what happens is you getting back to our debits and credits you debit. Since it's, uh, cash, something's going to be cash. Let's say they're giving you. Let's just say they're going to be $5. They're only gonna buy one share, which again doesn't happen $5. So now you need to credit. Now we know that a share of Parliament stock is the dollar, and you can't change that. You can't represent $5 here because they've only bought one share. So it's common stock for a buck. But we know because we're accountants that debits and credits need equal. So somewhere there's four box, and I think you know where this is going. It's additional paid in capital on. Do you often hear it referred to a pick? Um, I'm using C s just from our own abbreviations, but a pick is a very common term. It's additional paid in capital, and it's what it says. It's money that was paid in excess of the par value, so it's additional paid in capital. Somebody gave you four extra dollars for that share, which has a stated value of a dollar. Together these air five bucks on these air, both equity statement accounts. The reason people it isn't necessarily reflect current business needs to have a par value. Par value is kind of an ancient terminology, but it's remained stuck around. And what par value does allow you to dio. Let's say you have a lot of transactions. You have a lot of shareholders, and over time you've issued shares here, there every month of shares going out. You want that somebody wants feel, look at your financial statements and quickly tell how many shares so they have outstanding . Now it is reflected several places in the financials. But if you just want to look at the balance sheet and figure it out, you know that your common stock line so you have your equity section. If we were to zoom in on the balance sheet, he would have common stock. A pick retained earnings which we're gonna talk about here in a second. We know that this represents every share for every share we sell. We enter a dollar in here. So if this was 112 we know that we've issued 100 12 shares because we always enter $1 for each share. That's and that's a quick way to tell. That also goes back. I referenced that companies off often set their par value it like one cent. It's because the one sent the $1 doesn't matter. It doesn't matter in a financial sense, how much money you pay, Like something's gonna pay five bucks. Regardless, they don't care what? This? This what? You know, if you have one sent here for 99 here we have $1 here, etcetera. The investor doesn't care about that. And all this account is really used for us to somehow represent how many shares were issued . So, you know, if these were one thing common stock, you would see a dollar 12 which you do some. Matthew. How do you think? Well, there were a penny each, so it's really 100 and 12 shares. A long, complicated explanation. But you at least now understand a little bit about the break up between common stock and a pick. If you take those together, that's how much shareholders have invested in your company. Um, one last thought. A pick can include other stuff other than, um, the sale of common stock. One thing that comes to mind is options. If your company issues options, you need to do the accounting for those and one of the transactions, which we're not going to get into. Just that it's a little bit more complicated. Is that credit to a pick? So there would be no reflection in common stock because it's an option. But there is that transaction, which hits a pick Treasury stock you don't see too often. Treasury stock is when companies buy back their own shares from shareholders, whether it's public or private. You see this a lot, um, in public markets say a company has a 1,000,000 shares out there and they're trading at once and just a drastic example. We'll supply and demand and the laws of economics. We know if there's less shares out there in the world, um, the price per share will go up because the supply has dwindled self weak. If there's a 1,000,000 shares out there, if we could reduce that to 500,000 maybe a share price would double to kind of offset and reflect the fact that there's more demand than there is supply now on. And that's when companies buy back their own shares. They're trying to increase their stock price. Um, and fairly was fairly so I mean, they want the share price to attract other investors. It's kind of a long list of why a company would do that. It's not just a simple transaction, but the point being is when a company buys it shares back, it's listed as Treasury stock, and it would be an extra line on here. And it's so that readers of the financial statements comptel how many shares were brought bought back by the company. And typically those shares can't be reissued. They're just held until they're canceled. So the company has to cancel him out or just leave them in Treasury stock and reflect the fact that they bought back shares and then retained earnings. I wrote Ari here it's retained, earnings retained earnings, and this will be your first lesson in how financial statements are linked, and we're gonna keep it simple until we get to them. So all the financial statements are linked. Habits equals credits off that retained earnings represents the link between the balance sheet and the income statement. It's on the income statement. You have your revenue, your expenses, your net income. So this is how much money you made, Velshi. You have your assets, your liabilities. That's liabilities under equity. Um, you have X, you know, x y z the dollars Your net income from here is represented on the balance sheet in retained earnings. So say, made a buck. In the course of a year, he made exactly $1 that gets represented in retained earnings as a dollar. And the reason is, is that one line item, the retained earnings line item. It takes everything that's on this financial statement and summarizes it. The end results of all the stuff that happened on here was a dollar. It's reflected on here, and it makes sense that goes to the equity section that that buck that the company made. It's something that the equity holders have a right to, um and that shows up here again. An accounting software. This happens automatically. You wouldn't have to do some journal entry or anything like that to move a dollar here. The system knows that whatever this end result is is part of retained earnings. And it'll all balance and the reason it bounces. Because, remember, you're doing debits and credits, and sometimes they happened between these accounts. Sometimes they happen here. Sometimes they happen here at the end of the day, debits and credits all equal, and it all ties together on the balance sheet. So, um, again, if you don't totally get that, don't worry about it. Just know that retained earnings represents what the company has made since the beginning point in time. A lot of times, companies will break this out so they'll show retained earnings for all previous years. So say they went in business in 2005. So 2005 to 2012. Here's our retained earnings number on, then for separately for 2013. Here's our retained earnings number, which will change each month because stuff is happening and it's coming over here. Once the year ends 2013 that number gets rolled in here in the Sun now be 2014. So combined. Those represent the amount of money that net income the company's made since the beginning of time. That's also where I mentioned earlier. You could have a negative equity section just a little aside. That's how that could happen. Say the company's losing a buck each period. You have a negative dollar coming over here. So say investors put in 100 bucks originally and it's being depleted by a dollar each month . By month, my months, your equity is gonna come down. You could have a negative equity. Um, hopefully don't see that it's on the next slide. We're gonna talk about common stock. So we went through a lot of this already explained it just to get you here. So common stocks, often given the par value and I haven't hear one, sent 1/10 of a cent. We used a dollar just in our example, and it's just to reflect that so and as I have on here this way, the number of shares is easily reflected. Say 1,000,000 shares would be represented at their par values a one cent or sorry, 10th of a cent I haven't here, which would be 1000. So if you saw 1000 on the balance sheet that said, you know blah, blah, blah common shares, you know, 10th of a cent par value, you know, to take that number divided by 1/10 of a cent to come up with how many shares are actually issue, the remainder goes to additional painting capitals. That's really take your common shares in a pick together is how much investment has happened in the company, and each share common stock represents ownership in the company. So you know, it's easy to get caught in the numbers that remember that those are actual people. Who is their shareholders? Who own equity of your company preferred stock, Um, preferred stocks given a par value and then, as I mentioned, typically higher. So it's usually, say, a dollar ship that's common. That's when I see, um, it's represented the same way. The dollar par value times the number of shares represents ownership in the same way. Just those prefer shareholders have preferential rights, so you know they get a state of dividend if the company's liquidated. That's when I didn't mention before preferred shareholders have a claim toe what's left over first. So whatever equities left in the company after you pay all your liabilities, preferred shareholders have that first right, tell the assets, and then common shareholders gets what's left over after that, which might be nothing. Hopefully, it doesn't come to that. You never have to deal with that, and you don't see it too often. Um, but the offset to this is the shares cost a lot more cost a lot more to invest and get preferred shares. So a pick additional paid in capital amounts contributed in excess of the par value of stock. That's the simple way to think of it. Taken as a whole, Comstock plus preferred stock represents the amounts invested in the company. So common preferred on a pick together is how much has been invested in the company. I did mention other things go in a pick I mentioned warrants. You can still think of that as money. Invest in the company warrants and options. Sorry just for your clarification. A warrant and an option for purposes of accounting and knowledge work the same way. Um, it's a right to buy shares at a set price. So a $5 warrant or $5 option means it gives the holder the right to buy a share for five bucks regardless of what the stock prices. But you pay for that, right? So you might have a $5 warrant that you paid a dollar for. It gives you the ability to buy shares at five bucks. And why would you buy that? You'd buy that because you think the stock price is gonna skyrocket. You think it's gonna go 20 bucks, but you have the right to buy it at five bucks the other way. Options. The words are used as there used as an incentive there, given employees, new employees, giving the board member for directors members, um, so they might get a dollar. You know, Warren intern option on the distinction is that warrants are for people who are inside the company. Options there for people are outside the company. They operate the exact same way, and I use the two interchangeably. So a $1 warrants given to a board member of the stock price skyrockets to $20. They exercise their warrant, which means they have just pay a dollar for those shares and they get the shares, which are worth technically $20 a share. All of that creates accounting transactions that you need to represent, and that value of the warrants goes to a pick. And that's all you kind of need to know for now. So we have an example here, just aside from the warrants, just going back Teoh common shares and whatnot. So investor A pay the $1 per share for 1,000,000 shares. So using our 10th of a cent example here now on the slides one million shares at you know a par value of 1/10 of a cent is only $1000 so you would show common stock. We don't have it up here any more of a common stock $1000 in the remainder, which we $999,000 would go to additional pain. And capital taken together represents a $1,000,000 which is how much they invested. So that makes sense. And with that common stock number, you can still tell how many shares who issued Treasury stock. So we touched on. This is well, companies require their own shares in the open market if they feel the shares are undervalued. Sometimes private companies will do this as well. Just they want to get rid of it. Maybe they have a contentious shareholder. I've seen that where they just they don't want to deal with this person anymore. They offer to buy back their shares. It reduces the public floats. That kind of thinking about public situation, though in this in this example reduces the public float reduces the supply shares. Ideally, that increases the price per share. Usually, too. It's a good indicator because if a company can afford to buy back its own shares, that means that has available capital. It means it wants to grow the business. It doesn't want to be as highly diluted and means that the shareholders are out there and it's diluted. So it's a lot of it is an indication of a lot of good things when a company buys back its own shares. Treasury stock does have limitations, though, so we see it on the balance sheet broken out. You can't vote, it can't receive a dividend. So it's not like the company can pay itself a dividend because it bought its own shares. That's not how it works. And that's not the purpose of Treasury stock. And that's why those limits are placed on it. They don't want a company saying, Wow, we really need a lot of votes at this next shareholder meeting. Let's buy back your own shares and then we can use those to vote. No, you can't do that with Treasury stock, so shares can. Then once they buy, the back could be canceled. You can reissue them publicly. You don't typically see that there's a bit of a process to do so typically, when you buy them back, you let them sit and or you just eventually go through the paperwork and accounting transactions to cancel those shares. So retained earnings, um, again, just to get into it a little bit more detail. So represents the cumulative net income earned by the company's since exception on I don't think I haven't. I do here in the three point so represents both losses on earnings. So whatever that number is, the dollar here goes to retained earnings. If it was a loss that goes to retained earnings, that account represents all the ups and downs. Comedy is often break this out between the current year and all other years. Usually the way they show it is, they'll show if they have the name retained earnings and they have something else retained . Earnings represents all the other years. The carrot year might say something like net income from current year. Something like that. It's pretty clear which is which. Um, and it provides the link between the income state in the balance sheet. That's this. It's because of the debits and credits. Everything ties together. And when you move this to here, this all works with that. You have, Ah, hopefully an understanding of the equity section. I know it's probably more complicated than you. Then you realize, I think at the end of the day, once you get past all the accounting part of it, just know that the equity section represents, um, what investors that put in and what's left after all your assets minus your liabilities and thinking back now that we've gone through each of the line items. If you have, um, your assets minus liabilities equals their equity. You have common stock, traditional painting capitals. That's money people injected into your company. Then you have your retained earnings so from the P and L. So that's a positive number as well. The companies generated profit over the years, and that's additional money that you're in your equity section, that your shareholders have a right to. Likewise, if the company's been losing money, that reduces your equity as a whole, doesn't it? And that that makes sense, because then your shareholders, you know that equity numbers less than total investment because you have a negative in there. So they have a claim unless equity than they did when they originally invested. So it all kind of makes sense when you think through how it works logistically. So we've talked through the balance sheet. Now next, we're going to get into the profit loss or income statement in the sections and how the transactions flow on how it all works. 8. Accounting 101 Expenses: So now we're gonna talk about all the other expenses on your P and L. So we've talked about revenue, cost of goods sold your at your gross profit line. Now you have all those other expenses down below, and they're called operating expenses, if you will. All things you incur in your daily business activities to make the business happened. So just some general information first on out felt an outflow of cash. That's typically, um, made in exchange for a product or service. So you pay your employees, they work for you. You pay for airline tickets, you have a service. You get to fly somewhere for a conference. Typical expenses. You can think of things like that. Meals, entertainment. We're going to get into a lot of more specific ones on breaking them out. So there's several categories of expenses and these air kind of three standard ones. That's not to say there's not Mawr or you couldn't break out mawr if you wanted to. Um, these air kind of high level categories I often see so selling expenses would be things like marketing advertising, the employees who are in marketing and advertising going to conferences, trade shows all those things would be classified a selling expenses, giving out samples, research and development. So if you're in that type of industry where you spend a lot of money developing new products, doing the research, all those expenses to be in there, and they can be quite quite happy and then lastly is G and a general and administrative. And that's very common term and classification of expenses. And it is all things like travel, salaries, everything else, basically everything that's not specific to those other categories. And I mean, I keep mentioning travel. LA Times companies will break out travel as its own kind of main heading category. If it's an important expense, if it's something that happens a lot makes up a big portion of your expenses. That's when companies kind of make the effort to break it out on their financial statements . So first we'll talk about selling expenses, these expenses directly related to sales and marketing. Um, the reason we break selling out our R and D or anything else is just so the company can easily track it and related to revenue. So thinking of P and L, and depending on where you're looking at it. If you're looking at a P NL that gets filed with the Securities Exchange Commission, it will be very summary level. It will be selling Senses R and D G and A. That's it. Reader of that financial statement has no insight into what made up each of those not 100% sure they can read the notes. But on the financial statement, that's very summarized internally, though you might run a full, detailed financial statement of PML, it has every break out. So for selling, it has each line item for Gina. Each line item on that's fine. Um, so you kind of tailor the report to your audience and what you want them to see on what makes sense. Um, and here I have the common that's broken out so the company can easily track it. So even if internally, somebody was looking at the summary one with just the major categories they could look at and go selling expenses, really jumping up. But that makes sense. We hired some new people, and we did a big marketing effort. Whatever the case may be, um, back the selling expenses include salaries, direct advertising, marketing samples. You give away any travel related directly to the marketing efforts. Test groups anything you want to classify selling that makes sense like you want to properly kind of categorize items. And then it's up to the company to determine what is included. Accounting isn't always an exact science. I mean, sure, we have our debits and credits Universal Rule our financial reports how things after presented the time period. So there's some sort of hard and fast rules in accounting. But then there's things like this. Like, do we classify that conference as a selling expense? Or was it just kind of, Ah, General Conference that we went to was unnecessarily marketing related? That's a determination the company has to make, and the determination will just impact where it falls on the P NL. It's gonna fall in the PL. Regardless, it's just which category it's in. So now looking at R and D research and development expenses. So these expenses directly related to R and D of new products, new services, not all of R and D expenses translate into future projects. A lot of them are just abandoned. You do the research, you do the development you find out it's not gonna work. So you've incurred a large amount of expenses that don't translate into a final good or service. And that's one of the reasons you break that out because people know this is almost a speculative expense, if you will, um, you hope to see a return on that R and D, but not necessarily on. It's certainly something you want to keep your arms around, and that's why it's broken out. Um, R and D is common in a medical bio. Science, life sciences, those types of things, technology type companies trying out new technologies. That's where you see a lot of R and D. You're not going to see it so much and say, like a widget manufacturer business. Um, so here we have. Ah, example, a diagnostic testing company spends one million to develop phase two of their testing service very common. That's actually an example pulled from one of my clients in the past, so three amounts can be fairly substantial. Um, and you do you invest a lot of time and the reasons you're looking for that next big home run our next product or developed the next phase of your product. So jean expenses. What general administrative is kind of all else on. And it says on here all other expenses. Typically, it's salaries, rent, postage, travel, payroll taxes. Anything else falls under here on, and I should mention just speaking of salaries, we kind of talked about your marketing staff would be underselling you're and these staffs that you have people are specifically devoted to R and D. They would fall under the R and d category, all other salaries to say, like your CEO, CFO, general office people, whoever would fall under just Gina expensive, um, its unique based on each individual company How you have your expenses organized? Um, I've seen a real estate company. Is online real estate company broken out between real estate staff and all other basically , G and A. And that's how they classified it. So it's you make the determination based on the industry you're in and what makes sense for your company. So it's typically tracked on a detailed level in accounting, but then presented in a summary level in financial statements. So again we might have that selling are indeed G and A That's it. That's all you see on a financial statement, but really under G in a. There's 20 categories of expenses that make that up, and you can look at that if you're depending on your purpose and what you're doing. You know, if you're looking at doing some analysis, you might want to dig into that detail. If you just want a high level snapshot of how financials air panning out month a month, that summary level might be all you need. So some other possible expenses just to kind of get your thought process going on, where to classify stuff and what goes on there. So there's other expenses. Another income are represented separately. So I mentioned the bank interest you earn in the previous lecture. You, um, you earn interest on the amount in your bank account. If you just received a large funding, that could be substantial. Um, but it's not really revenue to your company. So that falls in another section called other income and expenses. So be interest earned. Also interest paid if you have loans or paying interest on its in that other section. Um, non operating items are also expensive, so interest expense. I just mentioned depreciation amortization we talked about in a different lecture, but that's kind of a non cash expense. If you remember, we're reducing the value of an asset. So we bought a truck for 100,000. We'd appreciate it over 10 years, which means we recognize $10,000 expense every year to represent the book. Value of that truck is declining and as a part of our operations were using $10,000 in value. So that shows up as depreciation expense. But it's not really an expense that you incurred in that period. Specifically, you didn't go out of your way to use that truck. It's just part of business. Um, so that's why it falls in kind of like another category, if you will. You don't have a lot of as much control over that. It's more of an accounting function. I'm in income taxes. I mean, that's another one where you don't have a lot of control. I mean, sure, you could do tax planning and all those things, but it's an expense that just kind of falls out from being in business. You didn't specifically choose to pay income taxes, whereas you could specifically choose whether to spend money on travel. You can't really choose whether or not you pay income taxes, so that's why it's kind of on other expense, if you will. With that, that's kind of, uh, overview of what expenses are on the profit and loss again. We're just trying to kind of walk you through all the sections of the financial statements . We're gonna get into each of these in a lot more detail when we actually start looking a building, bouncy profit loss. The other financial statements, um, and then even more fun is once we start analyzing them later in the course. 9. Accounting 101 Revenue & COGS: So now we're gonna talk about revenue and then cost the revenue as well, which are on your profit and loss statement. Kind of the top section. Eso the first thing just to get a start up some general information. So your revenue will often also be referred to a sales or income at caution you against using the term income just cause when you look at a P and L statement that bottom lines called net income. Um, so if you toss around the word income, people might think you're talking about that and not your actual revenue. So I would try to stick to revenues, and that's kind of the term that you see most often. So revenue represents what the company receives in exchange for providing its goods or services. You know, you sell that widget to somebody, then they're happy for a dollar. That's revenue for you. You run a consulting business and you do one hour's worth of work for somebody that's your revenue. That one hour's worth the time that you charge for a swell all revenue has a direct associated cost with it. So cost of revenue, um, more specifically, we refer to cost of goods sold when it's an item or referred to cost the services when it's a service, and we'll talk a bit about how we come up with those numbers. So just speaking of revenue, first of all, eso. Typically there's two types of revenues. Goods and services. The companies will often show those major categories on their P and l. You know, revenue from services revenue from sale of whatever it is you sell, widgets revenues, the closely watched indicator of performance. So later on in the course, we're going to get into performance ratios and doing analysis. Revenue will be tied into a lot of those ratios. If anything, Noah's well, you could just look at your revenue over time. So without comparing it to something else or doing some crazy ratio. Just seeing how your revenues growing, um, or contracting is a good indicator of how your business is. Performing on That I mentioned is used extensively and ratio analysis and revenue represents earnings from the primary business. So I don't want you to include things like Interesting comes, so if you put a bunch of money in the bank so you get like $5 million from investors. You're gonna earn some interest off that hundreds of dollars a month? Um, that's not the money you're generating through your primary business. You're not in the business of putting money in banks and earning interest your in the business of selling widgets So interesting. Come while it is income revenue tax revenue. But it's money coming in. The company gets demonstrated on the lower section of the piano. Well, look at that. But it's other income and expenses and the other income. So just keep that in mind that revenue on your P and L is true revenue from your operating activities. So cops to goods and services. And they were gonna dive into each of them a little bit more in detail. But basically it's an offset to revenue to determine gross profit and drawn something up here that we're going to go through but typically have re revenue less your cost of goods or service come up with your gross profit. It's referred to his cog, so if you're selling an item, it's cost of goods sold, so it makes sense be 50 cent widget. You know, it's the example we've been using or cost of services. If you're in a consulting business, which is the service example I like to use, you have consultants running around you charge $100 for their time. You pay them 50 bucks an hour, so your net near your gross profit on them. It's 50 bucks. So those costs of good solar the cost of services represented direct costs related to earning that revenue without incurring those costs. You couldn't have the revenue piece. You couldn't have the service revenue without the consultants they're paying. You couldn't have the revenue from selling widgets without paying for the widget. So that's why you break that out. And we do see a revenue cost of service or goods and a gross profit then and then under this will have all our other expenses, which we'll talk about later. So a little bit more about cost of services so typically represents direct labour. So have example on here. Come suddenly, Company builds 100 bucks an hour. They pay the consultant 70 bucks an hour for their time. They make 30 bucks per hour on the consultant running around doing what they do. It's fairly straightforward. So, um, it's not too difficult in that situation to figure out the cost of the service. And you do want to see that because you can then track how things were performing and making sure that your gross profit is consistent. We're going to get to an example, So cost of goods sold. Circosta gets sold, is back to the widgets. You pay for the item. I think we have our hands around this. Now you pay 50 cents around here. I have $70. You pay $70 for the widget. You sell it for 100 you make 30 bucks. That's a fairly direct relationship. Without buying that widget, you couldn't sell that widget. So it makes sense to kind of group those together and come up with a gross profit. So before we move on, we're gonna talk a little bit more about when cost of goods sold. Kind of takes the next step and gets a little bit more complicated and manufacturing my rant. I want to talk about this. What this says is, you know, example of why it's important to look at things from different, different aspect. So here we have January, February, March, our revenue we had $100.50 dollars, $1000. So if you were just to look at that, you would think, Well, something went wrong here. You know, we sold half of what we did, You know, in the prior month's is just a bad month. February's a short month. Who does you figure that out. But then you look here in the 1000 bucks. You know, we did pretty good with 10 times here 20 times there. So we did something right in March is what you would initially think. Then you start looking at your cost of of certain lists. Pretend this is the cost of service. That situation, these air consulting hours and revenue 50 bucks an hour is what you paid your employees 25 bucks. So that's consistent. You know, you have a 50% gross profit margin. 100 100 bucks. You sold it for 50 made 50 and that's 50%. Same thing here here, though. You made 1000 bucks, but he paid 700 bucks and cost of services paid your consultant similar bucks. So you only made 300 bucks or 30% is what this is a 30% margin. So you were making 50 and now you're making 30. So what went wrong here? So because we were excited about 1000 bucks, but now we're only making 30% on that. So what's the story? And it's this type of analysis is a b A taste When you get into analyzing financial statements that you make your ears perk up and you want to figure these mysteries out in the solution, One solution I would offer is that you hired better consultants here. You had to pay them, or so you made less per hour. But you were able to sell a whole lot more hours, so that makes sense. But those are things you would figure out. So, Justin example of analyzing kind of like the revenue and costs a good soul, Um, that aside, going back to selling widgets now. So we've always used a straightforward example of you by a widget. You sell a widget by for 50 cents self for buck. What happens if you are more of a manufacturing? You assemble widgets, you build something so you have a final widget. But what goes into that? Which of the three parts part ABC. So you buy all those. So to come up with that final cost of that widget, we need to do a few things that we're gonna talk a lot more about this later in the course when we get the inventory, accounting and cost accounting, but just give you a taste of how you know this number of your cost to get sold is developed . Um, you would take the individual costs of those three widgets, ABC. So $1 each, let's say three bucks, then you also have some direct labour. So somebody had something that works for you had sit there and assemblies, widgets, gloom together, maybe machine them, smooth it out before it's ready for sale. So their cost of labour say it takes them an hour to do that in the paint 20 bucks an hour so that 20 bucks needs to be built into the cost. That's time that they could have been spent doing something else, but they were spending a building this widget, this final widow. So now you're cost is the $3 for the three pirates, plus the 20 bucks that the guy sitting there assembling up and lastly, have indirect costs. So say it was some advanced machinery this guy uses on and it burned power like nothing else. Um, and used up $10 in just electricity, like assembling this thing and gluing it together and packaging it, making it final. So now you've got the 20 labor, the $3 for the part in the $10 an indirect costs have a $33 thing, but that's how the cost is develops. You have a $33 widget now for sale. So it's not just the $3 that you paid for the parts. It's all the other stuff that went into it. And that's cost accounting. Just a simple taste. Um, the reason why that's important is because that's what the 33 bucks is, what shows up here and cost of goods sold when you actually sell it. That's what it costs to come up with a final part or finished good. That was ready for sale. So just keep that in mind. We're gonna talk more about it with that. That's it for revenue and custom goods cost the services. Hopefully, that all makes sense. Next, we'll talk more about all the other individual line items on a P NL. The other expenses, if you will, operational expenses, and that's it. 10. Accounting For Fixed and Intang Assets: So now that we've gone through the balance sheet on the P and L in the different sections and giving me an idea of what types of activity happened on each of those and how to look at them want to jump back to the balance sheet and talk about fixed assets, I don't I don't think it s so I want to spend entire section in the course on fixed assets . But I did want to give you more information because we have talked a lot about appreciation and things like that. So we're gonna talk about fixed assets a bit more. Um, the first of all fixed assets are referred to his peopie any property, plant and equipment. Um, long term assets which contribute to the company's operations. I've been using example of a truck. You buy a truck expected the last 10 years. You use it in your operations. Maybe you haul something, Um, and it's an asset which can be easily converted to cash. I mean, you could go sell the truck and he might take a hit, but you can't just turn around tomorrow and sell your truck. You need to get out there and try to sell the truck, advertised, etcetera and then intangible assets we're gonna talk about as well similar to fixed assets , and that's appreciate it. The only difference is you can't touch them. So I was used example of copyright a patent, those types of things. So some more examples of types of fixed assets. So I've been using the truck. But buildings land not often these days. You see cos by buildings the land. But think of a maybe a car manufacturer. They certainly owned their own buildings. Land. Excuse me. Cars and trucks. Manufacturing equipment. If you're ah, manufacturing type of business, you assemble those widgets. You have a lot of equipment and floor space in your warehouse where you're assembling those and you have specialized equipment. Those would be fixed assets destined chairs. Certainly, if you're in a lean start up environment, you still have computers, desks, chairs, a printer. Those air fixed assets have computers on here. It's a types of intangible assets, so patents, trademarks, copyrights, good wheels would have mentioned. But things you can't touch but are still assets. They're used in the generation of wealth for your company. You know you have a copy around something which gives you the right to sell that and you know nobody's gonna come and steal it. So that's certainly an asset worth some value. How you place the value on those is a discussion and on up itself, it's not off its not necessarily what you paid for it. So you paid 500 bucks for a copyright when you get into a kind of technical accounting, especially if you're a publicly traded company, if your private not as big a deal, I mean, if you get all the ends announced, that is correct. But typically you would have to have ah third party valuation company committed. Put a value on that copywriter that patent and say, Well, what type of revenue is this gonna generate for you in the future? What's that worth? Let's discount it. And that's really what your patent is worth. Your copyright is worth, so it gets a little bit tricky, and then you have to test for impairment. So if you hear things like that, all true all needs to happen. But for purposes of this course, I wouldn't get too hung up on that type of stuff. Just know that a copyright or patent is an intangible asset, which will be on your balance sheet. So amortization depreciation. We've touched on this a few times. Let's just kind of put the full picture around it now. So to represent the decrease in an asset's value. U book, amortization, depreciation and again amortisation is typically on intangible assets. Depreciations on physical assets, same concepts, same same exact thing. You spread the cost of that asset over its useful life. Come, it's a non cash accounting entry, and we're going. I'll show you the accounting entry, but you're not actually paying cash. You paid cash when you bought the truck. You paid 100,000 a month a month. 30 year. You're not paying any cash to appreciate that asked you, just reflecting the fact that it's falling in value. Um, impairment, I mentioned, is a sudden decrease in an asset's value more than the normal depreciation or amortization . That would be where you typically see impairment in things like patents and copyrights. It's more on the intangible side. Um, you know, you have, ah, patent on something you're producing. You think that patents going to generate revenues for 10 years But then somebody comes out with a widget that's just way better than yours. And they have a patent on their widget. Um, and all of a sudden it's expected that you're just going to see a revenues declined fairly drastically on your item, which is patented. He would probably have to taken impairment. Hit that patent isn't worth nearly as much as you thought it was. Say, it's your five, because somebody else has come out with something better and your technology is now dated and you're really gonna have a hard time selling it. That would be in a case where have taken impairment hit. It's basically a sudden write down of an asset, so amortization depreciations, some more notes. Tangible assets are depreciated. Intangible assets are advertised. Same mechanics accounting wise. So accumulated depreciation is a contrast. That account, which offsets the value of the asset. And I just want to show you Let's do an example now, and there is an example a little bit later, but we'll we'll go through both, so you see it's on your balance sheet. You have an asset. Let's use the truck. You have a truck. Have you paid 100. Just $100 freeze. You paid $100 for it. Typically, what you'll see then is accumulated appreciation. So in your one, this is zero because you just bought that truck. So you bought $100,000 truck. You know, week later, it's still worth $100,000. In theory, we know it falls value, but accounting wise, that's fair. So your net value on that truck is this minus this. So it's 100 bucks now in the year two, you have to record. So the way you calculate appreciation and there's several methods but there was common is a straight line where you spread this cost over the useful life. So we say it's worth 10. It's gonna be valuable for 10 years. So you would spread this cost over 10 years. $10 a year. You want to take a decrease in its value. You never change the value. The truck you pay $100 for the truck. What happens each year kind of off on the side. Your journal entry, your debits and credits is you recognize, um, expense. And that shows up on your profit and loss that we talked about depreciation expense. So this is where it would get booked appreciation expends truck. 10 bucks for the year. The offset to that. Remember, it's two sided entry Needs to be balanced is accumulated depreciation. So what the century effectively does It says we're gonna recognize $10 in expense for the appreciation of this truck we're writing off. If you will not tell them writing up your decreasing it accumulate depreciation is I mentioned a contrast that account. Now, if you think back way back to one of the first lectures, I talked about how some asset accounts can. You know if you're gonna increase and ask that you would debit it. But if you want to decrease and ask that you credit it, that's what's happening here. Accumulated depreciation is an asset account, but it's called a contrast. It accounted offsets and asset, and that's what's here. So this is your balance sheet. Now you have your $100 truck, $10 in accumulate appreciation. So your Net book value is a terminal. Here is $90 for that truck. That's what the truck is represented as being worth on your financial statements now and conversely, on your income statement, which I won't bother and run out. Um, you'll show your depreciation expense now again in paying the cashier. Remember that you paid cash when you bought the truck Here. You're just doing an accounting entry to represent, to reflect on expense and kind of reduced the book value of your assets. And this is the entire concept behind depreciation Amortization. If you understand this, um, you understand how to advertise patents? How did appreciate the truck computer? Whatever it might be? Um, just a few more thoughts. This is usually done by asset class. So if you have a lot of assets, you have, like, 10 computers. You don't do this for every computer. Um, use software to track your computers. You tell it, how long the computers a good for usually say, three years for a computer. And it does the math and tells you what entry to book each month. Or it might even be booking the entries for you. If you're using, um, your your software properly. Um, so keep that in mind, and then that's your book value. And then after 10 years, this will be 100. This will be zero because you had $100 truck, you fully appreciated it. And now the book value of zero. You don't necessarily get rid of this truck. Um, and you might keep it might get 13 years out of it, but it's fully depreciated, so it will have a zero value. If you were to go and sell that truck now for, say, so you found somebody who would buy it for 10. 15. In this case, there's a series of accounting entries to reflect that, because now you have asset that's valued at zero for all intents and purposes, but you're gonna make money on it. So some entries followed of that. We won't worry about them, but that's the mechanics of what happens. Um, one final point. Just add this in this calculation here, we're assuming it's worth zero at the end. Say, in advance you knew it was gonna be worth 15,000 inter calculation. You would have said $100 truck, um, less 15 that we're expecting to sell it for at least 85,000 so we would have depreciated 85 over the 10 years rather than the 400. If that makes sense, and again you would true that up periodically as he got closer. If you're like, this truck really isn't gonna sell or hey, this truck's gonna sell for 25 your true up, how your entries reflected. So the next side is methods of appreciation. So that's a very straight line. Evenly spread your depreciation. It's the most common method. Declining balance. You don't see these a lot, so I can spend a lot of time on the declining balances and accelerated method. So you recognize mawr of this cost in early year, so you might do $20 in the year 1 15 and near to 12 and year three. And there's different methods, even within the climbing balance, to calculate that what it should be. But you would do it in the situation where you have an absolute that loses a lot of value early on in a truck. You can almost make a good case for that. I assume you drive it off the lot. It's probably worth, you know, 75% of what you bought it for. It makes sense to recognize more depreciation early on. Not to say you necessarily do it for accounting purposes. But it's an example of why you might consider, uh, declining balance or an accelerated declining balance activity base. Another one where you could apply the truck if you so rather than just say, Well, I think that's trucks good for 10 years, you say, Well, I know this trucks good for 200,000 miles. Um, you know, I don't know how we're gonna use those miles. It might sit idle for two years, and then we use it heavily so you would spread that cost on a per mile basis. And then at the end of each year, you would look at the truck and say, Well, we drove it, you know, 10,000 miles, What was the per mile, depreciation and book that amount. And that's a fair amount. I mean, that's a fair kind of method to use. And as long as you're consistent, you always do that. That's fair. And again say you got close to the end of the usage you are up to 200,000 miles on. It was still a great truck. Um, you maybe would do some accounting entries to reflect that, or you wouldn't book anything. We just could keep using it till it's dead. Whatever the case might be some of years digits. You really don't see that too often. It's another way of doing the accelerated method. Um, just so you know what it is, in case anybody mentions it, say this was again a 10 year truck. The sum of years digits is literally 10 years plus nine years plus eight years plus seven plus six etcetera. Whatever that number ends up being, and I don't know what it is off top of my head, you would then divide, so you would say it was 100. I know it's not 100 but he would say 10 over 100 9 over 108 over 100. So again, you're just kind of taking more depreciation in the first year because it's a greater number of years left, and then it slowly declines just a method. It's a way to put a method behind the number in the calculation. That's consistent and somebody could recreate. So I have an example in here would probably write it out again by the car worth $10,000 5 year useful life on the car, 100,000 mile estimate no residual about residual would be what you think you could sell it for at the end. The straight line method. You would just divided by five years and take $2000 per year. Declining balance. You might take 40% of the book value and recognize that each year. So you're one. You would take 40% of 10 and you recognize 4000 bucks. So now your book values 6000 bucks. It's the 10,000 less before you recognize the six. The next year would take 40% of the 6000 and you would keep going down that path. Um, activity based. So 30,000 miles driven in year one. Um, and you estimate you had the $100,000 are sort of 100,000 mile estimate on it, so you would do the math. You've used up about $3000 worth of the value of the truck, 30% of the miles you expect to get out of it some of years digits, which I just showed you. 54321 And then you start dividing on doing the math that way, not common. And honestly, most likely you're going to see a straight line depreciation. Um, one other thing to keep in mind and I don't think I have it on here is the for purposes of income taxes. There's often different appreciation methods used or terms or allowances used on. That's where your tax account really figures those things out. And they're called permanent differences between what Your book show on what your income taxes show. So you certainly don't reflect on your financial statements what you need to for income taxes, your account. Your tax account figures out those differences and makes those entries for purposes of financial accounting, which you're focused on. You picked the method like the straight line method that makes the most sense. Um, final points depreciations, an estimate. This is again one of those areas where accountings not perfect. Um, certainly, you know the point being you want to pick a method, you want to stick with it. You want to be fair. You kind of want to re evaluate each year, so if it's not working, you're not taking enough depreciation. You don't want to get hit with that at the end. You want to fix it now and spread it out over the remaining years. Um, accounting always leans towards being conservative. So when in doubt, You know, if you say you originally thought this truck was going to be worth $10 at the end of their useful life and you're kind of a year or two in and you're like, probably not, um and in fact, I don't think we're gonna get eight years out of it. You want to reflect change the your calculation for an appreciation to reflect that. Be conservative. Um, it's never necessarily a bad thing to at the end. Kind of have on upswing. Okay, great. Actually know what it end up being 10 years, not eight rather than it be the other way. And you thought it was gonna be 10 and it was only eight. So, for example, if you have a near three, determine the car only has seven year life, you'd adjust your going forward appreciation. You never go back and change your previous financial statements. You can if you have no outside parties, interest in your financial statements, you never want to retroactively go back and change finances if other people are looking at them. But if you're the only person, and you want to go back and change them. Be my guest. But in general, you have outside investors, other business partners. They don't want to see past financials change because it just arises. Questions You're better off fixing. And now going forward. Um, so on day, as it says here instead revised the calculation, going forward to correct the book value and fix the calculation kind of start for us. OK, well, we've already written it down to 7 70 we figured only has five more years. Let's redo our depreciation calculation, and nobody can fault you for that. So with that, that's a glimpse into fixed asset accounting. It's really not too too difficult again if you could get your head around depreciating, and that kind of makes sense to you. That's the main point. So I appreciate you kind of threw accounting 101 Here you've learned all about debits and credits and the financial reports on what goes on them and, um, T accounts and depreciation all kinds of stuff. Stuff will continue on to get into a little bit more of the exciting accounting and financial reporting 11. Cost Acctg and Inventory Intro to Cost Accounting: the next section that we're going to get into now that we've learned the fundamentals of accounting in the counting one, the one that we're gonna get into cost accounting. So in this first lecture, we're just gonna talk a little bit about what cost accounting is the purpose of it. And then we'll get into more of the specifics of how it works in the next few lectures. So first off, just some general information cost accounting views to determine what it costs to build a widget. So we've been talking a little bit about you know, we have this final widget and there was some inputs into it, some some individual parts that, when assembled, becomes the final widget that you sell. And the goal is determine what is the final cost of that widget. It's not a simple is just adding up the cost of those few parts, and we'll get into that a little bit, uh, actually talk a little bit about it Now. The fully burden cost of a widget is what it's valued at an inventory and on the balance sheet. So I have the term fully burdened here. Fully burden means you added in all the other costs that are related to building this widget. So it's not just the three pieces. It's also the labor that was involved to assemble the switch it and also all the indirect costs that go into the widget. We will talk a little bit more about what makes up each of those costs individually and how you determine what specifically gets charged that widget. So when you're determining, oh, it's not $3 it's actually $10 it cost to build this widget. How do we come up with about $10 and then? Cost accounting also helps reflect the cost represented on the income statement of piano when the widget is sold, so the first step is determined. All the inputs. What is this thing cost? That's what it sits. An inventory as an inventory sits on their balance sheet is a current asset. Then when we sell it, we recognize the revenue. But we also have to recognize the cost of that widget on her income statement, and that's when that cost. The final cost gets moved to the P and l. So as you can see the cost accounting, it's kind of an important function of If you're in type of environment where you do assemble something, there's multiple steps you'll get involved in cost accounting. So the four elements are the three elements story of cost accounting are essentially direct materials, direct labour and indirect costs. And sometimes indirect costs are broken out between indirect labour and materials, but as a whole were just going to say it's indirect costs. I will talk even more about those in the future lecture where we talk specifically just about overhead. But those three components and that the universal kind of formula it's always those three components that go in creates the total cost of are finalized widget. So what's the purpose of Kosta? Can we kind of mentioned a few reasons already to come up with that final cost? But why is it important? So cost accounting gives management insight and profitability. So the example I like to think of us, you know, each of those three individual pieces cost a dollar, so someone might say, Well, it cost $3 for your final widget. The promise if you just stop there and did no more and didn't really get into cost accounting, you might say, Okay, it costs $3. Let's sell it for six And there you go. The problem is, is that somebody spent a lot of labor building the switch it as well as the overhead costs . So maybe in the end, what you thought was a $3 widget really was $10 to build. So if you're selling it for six without that extra input and information, you're losing money on each one. So it's important for management to know what that final final Costas so they can make decisions about how to market the product and sell it. So each segment of the cost can be examined and kind of refined as time goes on. So maybe traditionally it costs approximately $10 to build this widget, and then it starts to creep up. Now of a sudden that management seeing its cost $11 it cost $11 cost $12. What's going wrong? That's where your cost account can then go back and look at each of the components, direct materials, labor and overhead and see where the where the prices rising. Maybe labor's the same and overheads the same, but the materials cost has gone up things like that. So then again, management can make decisions about how to perceive. Do we keep building this thing that we try to negotiate better contracts, whatever the case might be? And then, lastly, there's the accounting impact on the balance sheet in the income statement, which already kind of mentioned. You want to make sure it's costed properly and they colorfully burden. So when you have the final cost and all the inputs air are added on to it and you have your $10 cost, that's a fully burden widget. And that's what it's gonna be represented as in inventory. And then when you sell it as well. So it's important to do that. Otherwise, what happens is they we ignored cost accounting, and we just left it at $3. It just costs the some of the three parts you would have a $3 part. You would think you were making more money on that than you actually are and is well, all those other costs would then just be sitting on your P and l. So the costs are still recognize, and we're gonna get into an example in the electric little few lectures later, we're all map it out for you. Um, the costal. I'll still be there on your financial statements. It just won't be directly attributed to the sales of the goods. So you lose that aspect of making informed decisions and then, lastly before then, in the next few lectures will get into each of the few sections in more detail. So cost accounts typical in a manufacturing environment, not so much in retail. In retail, you buy stuff and you sell it. You don't do anything to it other than put it on your shelf, that type of thing. You don't add any value to it by, you know, putting it in new box or machining it or anything like that. So think more about a manufacturing environment. Um, is where cost account is kind of most prevalent, and I always like to think of like a big, even though the examples I tell her, our three part widget that just gets assembled and sold in back your head. Think of a huge manufacturing facility where there's multiple lines and people building stuff, and then this part gets assembled with this part, Um, and their subassemblies. So you can see why it becomes even more important, because when you have all these inputs on all these different people working on things and they have different labor rates, the actual final cost of that good it would be fairly difficult to determine just by guessing and saying, Well, it has this, that that's why you implement cost accounting and cost accounting system. It figures all that out for you. Um, so and then I have mentioned here cost account is typical where there's multiple steps and inputs and creating the finished goods. So if it's just one step, you buy and you sell it, no real need for cost accounting. And then software drastically helps reduce the tracking and helps with the track and reduce the complication. Figure out what that end cost is, and we're going to talk more about standard costing when we get into each of the lectures to make it even one step further, kind of simpler on you, but still capturing what it is that we want to capture with that final cost So we don't lose the value in doing cost accounting, but we try to keep it as easy as possible So what? That we're gonna dive into each of the three types of inputs. If you will direct labour direct materials on overhead and then we'll have a final kind of inventory accounting lesson in the section. 12. Cost Acctg and Inventory Direct Labor: in the lecture today, we're gonna talk about direct labour. So we're focusing on the labour piece of manufacturing. A good So the example I like to use and we're gonna go through a few more examples later in this lecture. But again, we have the three pieces. We bring them in, we assemble them. So we're talking about that assembly, that person sitting there for an hour, putting these three pieces together. Maybe they then put it in a box and send it down the line. It's that person's time that we're trying to capture. So let's go through the slides. So direct labour, the actual cost. That's the time spent on the job times their wage amount. So a fairly simple calculation. If it takes this worker one hour of time and you pay him $10 an hour, that's $10 of costs that needs to be associated to that specific widget. So it represents the human cost of building the good that the companies sell. So again, we don't wanna ignore the fact that there's some process is this person has to do, and you have to pay that person to assemble this thing. If you just bought your three individual pieces. You couldn't just throw them in a box and sell them. You need that person to spend their hour of time building the Sinem. So it's that cost that you want to directly attribute then to the item so that you make sure that you fully capture what it costs to get one of these things out the door. So software makes it easier. So, um, I'll just mention now on this will apply for all the different types of costs, their software out there that will help capture all this time so worker might log into the software using their i d. They would say, Hey, I worked three hours on such and such a work order, and in such time, I process you know, 120 of these things. The system then knows to assign that cost to those widgets, and we'll talk a bit more about the software and how it actually works a little bit later when we get to inventory accounting. So typically, a standard cost is developed. So rather than have this rolling average, so imagine a plant in new build widgets and build thousands of these every day and there were the same product. Every widget is pretty much the same when it goes out the door, they're not unique. Some days the worker might take extra long time working on them and something's maybe he's really quick. He needs to get out of there. So he's trying to do. Is work a sassy camp you don't want to try and track on a specific widget basis? What, Costis? Maybe he only spent $8 worth of labour time one day on each widget. Next day spent $12 worth the labour time. On average, it works out to 10 on a normal day. Spends about $10 worth of its time exactly an hour assembling this widget. So what standard cost does for us is, it says, Let's just assume it's $10 an hour. Um, and the system will assign. So he enters his hours. He says he worked three hours on so many widgets. The system just assumes that he works at $10 an hour and it takes one hour to assemble each of these units and assigns costs in that manner. It's your cost accountants job to them. Look at variances and say, Well, it looks like he was being more efficient here and less efficient there. They figure that part out for our intensive purposes. We're just trying to figure out what is the cost to build one of these widgets. And you can imagine the nightmare if you had to try and track the cost of each individual widget. When you're building thousands of these every day or every week, you have to barco them and specifically show. And in the end it wouldn't matter because you're selling price would probably be the same. Regardless you're just selling widgets. So you're really just trying to come up with what is the kind of the average cost of this widget, and that's what standard costing does it just It takes one step out of kind of trying to specifically cost each and individual item when it doesn't matter, because we know is the whole the averages $10 labour $3 in parts so labour direct labour represents the cost of people needed to assemble these widgets. We made that clear, so each stage adds value and many assemblies have multiple steps, so we've been kind of using a very simple example of you. Take three parts to assemble them. We put him in a box and you sell it in any type of typical manufacture environment. You have multiple people. They're paid different wage rates. Um, there's multiple steps, and I like to think again about big manufacturing floor where maybe this person is assembling this widget and somebody is assembling a completely different widget over here. And then the next step is they take those two widgets and assemble them, and that creates your final product. Or maybe that thing goes on with something else. So there could be lots of steps. Lots of different people. Different wage rates difference about the time so you can see how it really becomes complicated on. And that's again, where the software really helps. People are just logging time and parts to a work order on the system. Calculates what the what the costs are in this building it up. So typically, I mentioned work our workers create it, which these foreign assembly, which the workers a lot of their time to, and that's kind of your operations manager. Your plant manager's job is they create your company might get an order for 100 widgets. So they create a work order for 100 widgets, which basically tells the staff, Hey, we need to build 100 of these and it goes through it's steps. The first person pulls the parts, they assemble it, they log their time. They also logged apart. So they say, Hey, I pulled part ABC out of inventory. That's how your system again knows where inventory is moving from and to they enter their time. It gets moved on. The next person there is there time. So the systems able to track all this information. So the first example to see is a simple one just gonna take it back a step so factory sells . A widget consists of three parts. They're assembled by hand. Simple assembly takes three hours on average, and the assembly persons paid $15 an hour. So the total direct labour is $45 3 hours. They spend times their wage rate, which is $15. That's the direct labor component of that. Not the materials are not the overhead, so that's fairly straightforward. One example tooth a little bit more complicated, so factory B cells, a widget which consists of 10 parts that are assembled by hand. Assembly takes 45 minutes on average, to some of those 10 parts. Additionally, though, when you have it all assembled, the final assembly has to be machined by somebody else for 30 minutes. So the assembly persons paid $20 an hour. The machinist paid $40 an hour. So what's what's the cost? And now you can see Oh, now there's a few parties involved and just multiply that by, you know, in a huge warehouse. Nonetheless, the told direct Labour is $35 per widget. So we had our $15 um, of assembly and $20 of machining for the half hour took the machine that So? So there you go. So you start piecing it together person by person and really just gets added on. There's no other factor involved, so that aspect of it is fairly simple. It's just accumulating cost until you have that final product. So with that, that's direct labour. In a nutshell, it really isn't much more complicated, only complicated pieces. You get a lot more parties involved, different wage raids, parts getting move along the line. That's the only reason it gets more complicated against software really helps aid in this. And I think to once your cost account will take a look at the costs and see variances. And, you know, should we be assigning more cost? Isn't really taking somebody 45 minutes instead of half a Knauer to assemble it. And really, we need to, in our standard costs, assume that each assembly takes 45 minutes. So that's your cost, accountant. Who's doing that analysis using the final numbers. Um, but for all intensive purposes, you now have an idea of how the labor is assigned to work order into widgets. 13. Cost Acctg and Inventory Direct Materials: next, we're gonna talk about direct materials, and I think this is probably the easiest concept to grasp. So now we're talking about those three parts, the part ABC that go into your widget, that your assembly. So it's the cost of all the parts used to create a final widget. Those have to be included in the final cost. Assembly could be one part could be 100 parts. And it could be a few parts here in a few parts there that get assembled. And then those assemblies get assembled. So, um, but still, though what happens is in that case is you have your few parts and a few parts that get assembled on these. What we call subassemblies get fully burned on Constant. So the direct labour for this sub assembly in the overhead would be assigned here the same here. And then those costs then come together to create the next piece, which would then also receive its labor and its overhead. Um, more parts, the more labor that's typically need it. So obviously as things move along was also specialized labor. You have a machinist, you have somebody in packing. You have somebody in assembly and somebody who glues it. There's all these different parties involved or paid different wage rates. And you have different people pulling materials from inventory different stages so it gets a little bit complicated. Eso the cost of materials originates with what the company paid so back there. Step one of work orders created. The first person in the assembly process has to pull parts when they pull parts and move them out of raw materials and in tow. Work in process. And we'll talk a bit more about the steps on the balance sheet when we get to inventory accounting and a few more lessons. Um, the cost of the materials is what you paid. So if you paid a dollar for you to these parts, that's what's coming into your work order as the cost of materials, the direct materials costs. That said, there's kind of one that's much exception. But one twist on that. So we mentioned standard costing when we talked about labor. So standard costing also applies to materials. It's the same thought process. You don't want to have to track the individual cost of each of those parts. If it varies, so say some days you pay a dollar 10 some days it pay 90 cents on some days, pay a dollar as the whole. Maybe you pay a dollar for those each of those individual pieces that goes in, you don't want to have to track. If this is the widget, they use the 90 cent piece or the $1.10 piece because it's irrelevant. In the end of the day, the average cost to build the widget is $3. It's those three parts Russians to build it, but the average materials costs $3 and that's what you're after. So that's where standard costing comes in, and in your system you'll have it set where part of her P part see our dollar. So when somebody pulls them, it's $1 of inventory for each of those parts coming out of raw materials into working process. You're getting your cost. Accountant will then go back and look at the parts that were pulled. The inventory, they're all costs about a dollar. The look at the actual cost and see if this standard cost is still fair and they'll do this on some regular basis, whether it's once a month or once a year, maybe a recorder. Maybe they cycle through it. And the point is to make sure that the dollar cost is still fair, and maybe they'll adjust it when they review it. But that's not your concern at this point. We're just trying to come up with a cost, but it just want to let you know that it out there in case you're wondering, Well, how do you account for the fact that it costs a dollar 10? But you're only using a dollar. That's why standard costing variance analysis. And then it gets Trudeau up so direct materials. So a company may buy parts in different sizes from different vendors. That leads to the different costs. You might get a bulk discount on parts when you buy them. That creates that different per unit cost. And again, it mentions hair standard costing. So things like screws, bolts you really don't want to. It would be pretty difficult to track a screw or bolt and say, Well, this bolt costs two cents on this one. Cost is 2.5 cents. You just have a bin of bolts you don't know which ones cost what again? That's the point of standard costing is to kind of make everybody's life's a bit easier without losing the importance of cost accounting. I think it's, um, you don't want to do this all for Not so. You want to make sure you're probably reflecting the cost that it takes to build this widget, and specifically we're talking about direct materials piece. But at the same time, you don't want to burn yourself so much. We're trying to track each individual bolt and part ABC, so it makes sense to do kind of an average cost or standard costing you think of a standard . Costco is kind of the average cost that we're recognizing for each of those pieces, so standard cost helps create efficiency. Standard casa revisit annually, typically to ensure the standard cost fairly represents a blended average. You might revisit it sooner if you had a reason to. You knew that you you bought a complete new set of inventory at half the price. He found a new vendor. Maybe then you would adjust your standard Kaufman here, and it's the cost Accountants job to examine those variances, gain an understanding of what's happening and do these changes this analysis on determine what happens and when they do make a change to standard cost that then kind of changes the inventory balances, and maybe the company takes an increase or decrease on the profit or loss. If you essentially write down the value of your inventory, you have to take the hit somewhere. But that's kind of out of scope of this. For now, we're just trying to understand direct materials and why the costs are the way they are. So an example. Simple example. So to build one widget to sell their 10 individual parts of the company purchases and assemble. So the final product also involves machining, which wouldn't be uncommon. So each of the 10 parts costs a dollar standard cost of the dollar. So the final assembly is the $10 in materials, which is what we're talking about. The direct labour, which we talked about in the previous lecture. So it takes that person $10 worth of their time to build it. So we have a $20 part and then some overhead, and we're gonna talk about overhead in the next lecture. But we would just sign some type of costs for overhead to come up with the final assembled parts, complete costs that you need to recognize an inventory and as well, then when you sell it. So with that, that's direct material. We're gonna die vinto overhead, which is a little bit tougher. Hopefully, you understand directly where materials. It's fairly straightforward. It's direct costs that are being applied to build and assemble this widget overheads a little bit kind of one step further beyond that, but I think once we get through, you'll understand why it needs to be done. 14. Cost Acctg and Inventory Overhead and Indirect Costs: Now we're gonna talk about the third component of the total cost of assembling a wedge in, and it's overhead or indirect costs and way use the terms interchangeably, and they're pretty much the exact same thing, so I might use one or the other. So first of all overhead and indirect costs are all the other costs to run the business. So thinking back to your profit and loss statement, we had revenues, less cost of goods sold, equals gross profit. And then he had all your other expenses, which was salaries, wages, travel, meals, marketing all those other expenses. That's what we're trying to do is take all those other expenses and say, What are they? What's the grand total for X period? And how do we assign that cost to the items that are being sold? So these air costs, which aren't directly attributable to any specific widget but they're incurred in the normal course of business? You know, you need to pay salaries. You need to you know you need to travel. You need to do sales and marketing efforts or just sell the widgets. But you can't say, Well, we've spent $100 on marketing, and we sold exactly 100 units because of that. It doesn't work that well. Unfortunately, it's not that easy. So what we're attempting to do with overhead and indirect costing is take all those costs and say, on a per unit basis, approximately, How much cost do we incur on average again? So we're kind of shooting for a best estimate here. It's gonna very month, a month you're in a year and again, that's something where we developed kind of a standard cost. We apply it for a period of time, usually year. And at the end of the year, your cost account looks back and says, Okay, we were a little bit off, plus or minus. Let's true it up for the next year going forward, but we'll get into that with some examples. So some more examples rent is a good one. Management salaries, utilities, travel expenses. So think of rent rents a great one. You rent this huge manufacturing facility when you pay $1000 a month, and they probably more like $100,000 a month for a huge manufacturing facility. Um, that facility is used to create all these widgets that you're selling, but you pay rent regardless of whether you make one widget or you make 20 million widgets, you're paying the same amount of rent. So for one at the fixed costs, and two needs to be spread over those units and how do you do that? And it's through indirect costing. So the methodology behind this we take all the indirect costs. So those all those expenses and then we pull them together and then allocating toe widgets . Somehow the allocation is typically done. I have here on a monthly basis. Most systems will just do it on a per unit basis. Um, again, what happens is just to kind of step away from this for a second. Your cost account looks at the trend. What it's on average, costed for overhead. Looks at the production unit says Okay, on average. Let's just say it costs a dollar of overhead for each unit that you build. So whatever left final direct materials and direct labour was at another dollar to cover all these overhead costs. And if we do that for every widget that we sell, were effectively coming pretty close to covering all of our indirect costs. And that's the point in this, Um, how you allocate that dollar depends. Most people would do units of production, so you know that it costs a dollar on average per unit of overhead. So for each widget built in the month, you just assign a dollar. And that's how it goes. Um, another way of doing is labour time spent. So they actually look at the direct labour that was spent on a widget, and they will sign based on that. So maybe one hour is worth, you know, a dollar. But on this other widget, they only spend 1/2 hour, so it's only gets half of that dollar. The reason you would do something like that is you build several different items, build multiple items, they take different amounts of time. So it's not really fair to just blanket. Apply a dollar for each unit. When this unit only takes a fraction of the time of this unit you want, apply the overhead and kind of a consistent manner that seems most fair. If you did only make one type of unit, you just make widget a units of productions probably fine, because you just make one type of units, you would evenly dispersed year overhead cost to those units. So the example I have here is overhead costs in the month of January was $10,000. Um, we produced $100,000 the units in this month, we would allocate 10 cents to each unit for the final cost. So in this example, I just want to be clear. We're kind of taking a very direct approach, indirect costs. But we're taking a direct approach and that we're assigning this specific amount of money incurred that month that $10,000 expenses to the specific units that were built that month . Um, so this kind of steps away from standard cost a standard costing. We would have just said it costs XML per unit. It doesn't matter what the overhead costs, actually, where This month we just assigned a specific amount based on the units. This is saying no. Let's take the exact amount of dollars, the exact amount of units and spread it over those which is completely find as well. Again. It's more about being consistent. So whatever methodology you pick, you do it each time A method like this takes a little bit more effort, if you will. Somebody has to look at this, look at the units of production, then go in and assigned this cost and somehow reflect that in the system as well. It's not just about doing it in a self spreadsheet. It needs to be reflected in the system. So when those units are sold, they represent the cost that was associated to them, cause the next month maybe the 10 cents ends up being 15 cents. So what's the point of doing this if you're not gonna have the cost specifically attributed to units? And maybe in this case, we have something that has a barcode on it, so you can track each individual unit? That would be fair again. It's a bit more work. It's probably a lot more work. But if company wanted to take this extra step, they certainly could. So, in example, number two overhead costs total 10,000 January there was $50,000 in total labour hours for assemblies built, and we built two widgets wee bit, but with a and will be and there are two totally different items, so 20 cents per hour be allocated to each assembly. So we today had 30 hours or 30,000 hours in total, so you would allocate $6000 worth of cost, which is the 20 cents times the the hours and then the other 1 20,000 hours times the 20 cents, which is 4000. So it's a way of splitting central. What we're doing is we're taking the $10,000 in specific costs and splitting it between the two widgets and the way we're splitting it is based on the labour hours. So you don't even s. I have to go through that. Matthews have to look at the ratio between how is the 50,000 hours spend? 30,000 was there Here, 20 was there to split the cost that same way again, like the first example. This is splitting the specific costs in that month and allocating it to those widgets. So what we haven't looked at, it's doing an example where it's, um, just a standard cost. And what? And it's fairly simple in a case you would just look at it and you would say going back to example one, actually, because we just had ah 100,000 units were produced at some point or cost accountant determined 10 cents was just this standard cost, so we don't need to look at how maney what the overhead costs actually were in the month. We just say, Hey, let's assigned 10 cents for each unit that was built. We know it might be slightly off, plus or minus ended the year. We true that up and we see if 10 cents is still fair. Maybe now it's 11 cents a lot easier. Process creates some variances. And again, that's your cost accounts job to do variance analysis, I think for our purposes, since we're more or talking about, like a start up environment or small business, just understand the concept of taking costs that we have and applying it to those widgets. So you have a fully burden cost of a widget, and you know when you go to sell that, did it cost $3 for the parts or two cuts? 13 The labour plus the parts or it really cost 14 the labor, the parts in the overhead. It really costs $14 to build this things. We want to make sure that we mark it up and sell it appropriately, and that's kind of the overall and nutshell The purpose of cost accounting. There's one more lecture in the section we're going talk about inventory accounting, and I'm gonna show you how the cost move and we're talking about raw materials, working process, that type of stuff. 15. Cost Acctg and Inventory Inventory Accounting: in this final lecture, we're gonna talk about accounting for inventory. So now we we have an understanding of where the cost comes from. So we have this labour, this material, melodies, overhead, costs that go into that final piece and then we sell it. So how do we now do some accounting for this type of things, since it's technically an accounting course? Um, so again, here it says assembled unit consists of those three inputs, if you will, on the balance sheets of step. Aside from those three items, there's three classifications of inventory on the balance sheet. I'm gonna write them out, and then we're gonna show you how things move. Um, the inner balance sheet in the inventory section will just kind of blow that up. We have raw materials, a work in process and finished goods double to say 23 and four $9. Over here we have our P NL revenue cost of goods sold ever growth profit. Then we have all our expenses. And then we have learned that income we won't fill in number Syria. So thinking back about our manufacturing process, we buy raw materials. We buy those three parts that go into our assembly when we buy parts and they're just sitting in inventory, We haven't done anything to them. We haven't assign them to work or nothing like that. They sit in raw materials. Raw materials is just what it is. That's the raw materials you're gonna need to build assemblies eventually, but you're not quite ready to do so. As soon as we create a work order, we got an order, and we wanna now bring materials out on the production floor and start assembling them. That's when things move from raw material to work in process. So working process at the end of the day, if their stuff out there on the floor, because we've kind of been using example where they kind of whipped through and they build something all the day. It's kind of the assumption, but really somebody might take three weeks to build their assembly. So while that inventory is sitting on their desk and they're working on it in this signing cost to it, it's it's a work in process on the balance sheet. The significance of this type of thing is that it comes to an end of a period safe. 12. 31. It's your year end. You're gonna want to see Well, how much do we have? An inventory? How much do we haven't working process that will talk about finished goods. But how much do we have here? Um, and that's important. And companies do analysis based on that. They want to see they know that materials and working process of stuff. They're developing the cell, so that can sometimes be a good indication. Nonetheless, the once the item is done being processed, all the direct labour and indirect costs are signed. The work orders closed out. They say that moves out, and then it goes to finish goods. Um, so it's it's and finished goods. And the example We've been using us what you call a just in time manufacturing process. We got an order and we built it and we shipped it out the door. Ah, lot of companies just build stuff. They're just building inventory continually because they know they're going to sell it. At some point, they might not have a specific order for it. So when that item is complete, but they're necessarily have a sales order for yet it will go to finish good. So finished goods, everything sitting and finished goods. Those final assembled widgets has all the parents has all the labor, the indirect costs assigned to it. It sits there. So what happened next is now we get a sales order and we sell some of the finished goods. So we have our costs here. We just have kind of aggregate numbers. So you have excellent apart sitting around materials that add up to $2.3 dollars, $4 say, at this point, just kind of an aside. Here we have decided that each piece that we sell is worth a dollar. Let's just say a dollar again. Remember, these represent aggregate amounts. Let's just make these 203 104 100 to make it clear. So one unit of inventory is the dollar. So we actually have 400 units sitting and finished goods. So when we sell something so say we sell 10 items 10 units, we would take the cost. The final cost of a dollar times how many we sold. That's your cost of goods sold say we sell for $2 each. So we have $20 in revenue and are gross profits $10. What we've essentially done is we've captured a lot of the cost that we incurred here in previous months to build this stuff, and it's already reflected in here. So what we've done is we've moved expenses over to our balance sheet for the time being while we build the stuff than when we sell it. We represent the cost here, so we never truly don't recognize an expense. It's more about matching the timing, um, off when it's incurred and when it gets sold. You know, the expenses incurred, say, in January. But really, we're building stuff that's not gonna be sold till March, and March is when we want a fairly represent that that cost is $10. So it's matching. If you ever heard of the matching principles matching um, both their expenses with the time period that the relevant in. So it's now when we're selling it in March that we want to recognize the direct costs and direct labour and all those things that went into building it. So that's kind of another reason for cost accounting is it does this. It moves costs over here, we add them up, then we move them up here when it's time and when we sell it. If we didn't do cost accounting, um, you would still have your pieces. You would buy raw materials, moving the whips and then finished goods, but you wouldn't add any direct labour indirect costs. So what would happen is in the month of January, you would have your labor costs in your indirect costs in January would have no revenue and no cost, because in sell anything, let's say this is the first opening of this company. And then come March, you would have the revenue that you'd have the 20 bucks. We wouldn't have $10 in costs anymore because it's not a dollar anymore, because we eliminated the labor and the indirect costs. Now it's only 50 cents a. So you would show 50 cents times 10 would be $5 and you'd show 15. But you'd have zero expenses down here, so it was a one time production run, so they kind of have weird financials. You had Jane where? Where you had a bunch of expenses, but no revenue, no cogsa. You have march where you sold the stuff. Looks like you made a great gross profit. We have no expenses because he did all the labour back then. Hopefully that clarifies somewhat why you would move and try to match these costs. You want fairly represent your financial statements because when you look at these, I mean, sure you're thinking, Oh, well, that's gonna look great. We made $15 in gross profit. We had no expenses. We have a net income of 15. That's true. I mean, on a the statement you do. But you kind of forget about the fact that in January you had a bunch of expenses related to this that you sold, and that's where it's kind of unfair. And you want him. Make sure you're not cheating yourself in a sentence and your shareholders and all the other financial statement readers because, um, you want to clearly represent what it costs to build and sell these widgets. So again, another reason for cost accounting and matching all of this stuff up. So now just talking about tracking so enterprise resource planning and I talked about the system and software before, um, e r. P software is kind of this huge. It's like an accounting systems to say like a QuickBooks. But on steroids, it's typically huge company wide. It covers everything so the labour people can enter their hours into it. The shipping people come to shipping through it accounting, payroll, all the stuff. And it's all tied together into, um, accounting system. So every transaction that happens is adding things. You know, you run payroll, you buy inventory, you move inventory. It's all being reflected properly in accounting. And that's what year peace offer is meant to do. Um, all this mentioned here, you get customized AARP software like some vendors build specific, um, software for the environment that you're in. Um, for example, a long time ago, I worked in an aerospace manufacturing plants as an accountant, and they had specialized AARP software, and all this company did was build software for aerospace type of companies. So it was very tailored to that industry. So and that's terrific. That works well with the air piece software. You can run reports to analyze variances and aggregate inventory per classifications. So you could look at this in all different ways. You could see how many parts you have in raw materials. What those parts are the break out of this $200 say where it sits in different parts, Um, and then as well you can look, because we've mentioned before our standard costing. So maybe we're using our standard costing method here, but the actual costs are slightly off. And what's the your soft world do is look at the variances and show you where parts air off . Maybe you paid way more for this part than your recognizing. It will kind of highlight those for you. Um, an inventory. So this section on the balance she can can amount to a large asset, depending on the company that you're in. But it's something you want to pay a lot of attention to. And your auditors will pay a lot of attention to it as well. If it's a substantial part of your process, and most likely if you're in a manufacturing environment where costs accounting is necessary, this is gonna be a big part of your balance sheet. The head of audit this yourself. How do you make sure that the inventory is moving properly? You know, you have all these different parties involved assigning stuff toe work orders, they say they pulled three parts, but one part broke that has grabbed another. They didn't necessarily do anything. The system. How do you just get your hands around all that? And the way is there's two methods. Cycle counting in your end inventory. So first we'll talk about cycle counting, which you're probably less familiar with. Um, so it's an ongoing method of doing inventory, and I should say, this is more of, ah, the more common method the company's used now, I think in the past, that used to be a year end inventory where it's now cycle counting us more utilized. So it's an ongoing method where your system typically randomly selects a bunch parts that evenly spread thumb over the year. So if you have 365 parts, it's gonna have you count one part every day. Um, and it says, Go count this part and it just prints out of sheet without it doesn't tell you how maney it thinks that has your system. You go, you count it, you write it down, and typically you would have somebody else do this and then they come back and give it to you. So there's no you don't know what it is in advance, That type of stuff. They go uncounted, they bring it back and you go, OK, that they say we have 10. You look in the system. Oh, way. Shall we have 11? Somebody must have maybe pulled an extra part and then tell us they broke one, and then they would make adjustments. Um, where you have thousands and thousands of parts. The system usually doesn't ABC method, so ah, high cost item of mid cost on a low cost. You don't want to just focus on low cost items. Um, and then it comes your end, and it's like, Oh, we don't count in the big items to guess what? There's 10 missing. You want to cycle through evenly through all the parts, regardless of value, and want to make sure you capture all the parts. Um, and as it says here, all parts by year end within a year period should have been counted once. And keep those records. You know, those hand written counts, the adjustments you do in the system. Um And then what will happen is that your endure your outside auditors will want to see those, But if you have done that all properly, have major adjustments. Any time there's a huge variants, you go out and analyze and try to find apartment. We just got this place and what not it was. You have all that for your otters and say, Look, guess we've been counting. We've been adjusting. There's no huge problems. We didn't write off like millions of dollars. The inventory. They're gonna be happy with that. Another method is a year end inventory count, so it's a one shot. Just shut down the facilities for three days. Everybody on board counting inventory. You print out the full list of parts, and everybody's assigned different parts, and they go count them and write them down. So it's usually done the first few days of the new year just because then you can have accurate year end reports. Your auditor will usually want to be president and help test count this because it's like a one time deal. They'll show up for that. They don't show up, recycle counting, but they'll show up for this and wanna get involved. I want to see some of the counts in my council parts themselves, unless just part of their auto procedure. They have to do so. It's fairly labor intensive, you know, last a few days and interferes with operations. Um, and again you find discrepancies, But you kind of find them so far after the fact, you don't know if the discrepancy occurred back in January or in November. But now you have to book it, and you're probably gonna be worse off. Whereas if you did the cycle counting, it's a lot easier to say. Oh, we're missing a few of these and actually spend the time and look for them. Whereas if you're doing a year and inventory, you're under a bit of a time crunchy of everybody running everywhere. Um, you have more people involved who are necessarily familiar with your inventory because you're just gonna have everybody counting, so it creates a bit more havoc. So my suggestion is definitely implement a cycle counting procedure if you can stay away from your end inventory unless it makes sense. For some reason, maybe you don't have a lot of parts. You don't have a lot of inventory. Just one account once a year. That's fine. Do year end inventory. So with that, that's, um accounting for inventory. We kind of walk through how this moves around. We talked about standard costing. All the inputs directly were direct overhead, or we'll direct materials directly were an indirect overhead and indirect costs. Um, so you know how to assemble the cost of a widget that's now reflected here and finished goods and hopefully that you have a great understanding of inventory accounting, a cost accounting. 16. Fin Stmt Prep Balance Sheet Preparation: in this next section, we're gonna talk now more about the financial statements we're gonna focus in on the four financial statements. Um, I'm gonna walk you through how to prepare each of them so I'll just start off by saying, For the most part, your accounting software is going to generate the financial reports. You're not mainly adding up numbers and trying to take anti them. So thing actual process of preparing the financial report isn't as burdensome as it might sound. I'm gonna walk you through a few do's and don't and what you can expect from them and then you'll see, is a download for this section or some sample financial reports there for a company called Be Square actually used to work there a long time ago. There publicly traded companies so that information is available out there on the SEC website. Edgar, if you go to it Elektronik downloadable information for each public company that I think it's a valuable resource, regardless of who you look at what that said. So you can look at those financial statements just to get a sense, but we'll walk through them now, just on a general kind of high level terms of what goes on each of them, and we're going to start off with the balance sheet. So So first off accounting software will help create all the financial reports you need with the correct specifications. So your small business, your startup, you're most likely using something like a QuickBooks. And I'll just assume that's what it is, because I don't think I've seen a company. Is anything else really? Sometimes use fresh books and things like that, Um, but they will have built in financial reports. You can go to reports, profit and loss statement and then choose your parameters what dates you want, and it will kick out a profit or loss statement or balance sheet as of December 31st. All those reports are built in, um, so speaking against specifically about the balance sheet. So you normally present a balance sheet as your current date compared your prior year end. So if you think back to one of the early lectures, I mentioned that some people will just use their accounts offered to prepare trial balance , and they put that on excelled, and they kind of build their own financial statements and the reason they do that because they want a custom tailor how they present them. Now. I have mentioned here that bounce she's usually presented as of current day compared to the prior year end. So maybe June 30th 2012 compared to December 31st 2011. QuickBooks can certainly do that. There's custom reports in there that you can do. Um, that's not a problem. It's not so much that your system can't do it, but some people just still like to do that process mainly and roll it forward and whatnot. But that's normally how it would be presented. And I'm talking more about a public company internally. If your again your small company, you just want to see a balance sheet, you might just look at the current balance sheet. I think there's a lot of value in comparing to prior periods, and that's why we do this. And that's why public companies have to do it because the value is there in doing the comparison. Andan example. I have a September 30th compared to the prior year of December 31st so the header eso normally it has three aunts and we'll kind of build a balance sheet here, if you will. So we start off with company names. X Y Z, the co balance sheet. It will literally just say balance sheet. Will this right? We'll do an abbreviated version, and then it will say, as of December 31 x wise, the whatever the date of 2012 and that's it. Sometimes down here in brackets, it will say audited or unaudited again. That's more for public companies that do actually get out. And it just so you know that what it iss. Conversely, we'll get to this, perhaps in the next side. It's not on the next flight, but we mentioned that it's the year of So maybe we did June 30th 2012 and December 31st 2011 and they will be numbers here, it might say, unaudited here and audited here. So typically only audit your gear in numbers. So if you're comparing to your end and you're at an interim period, these numbers are audited. These air just what they called reviewed. Your orders will look at them, but they don't do the level of detail inspection that they do in those. So, um, not super important, but just So you know, if you see it, um, over here, then we'll have assets. Liabilities, Equity with total three section. It will be consistent over there and again. If you look at that example for B Square, you'll see this exact kind of format. And that's very standard format for balance sheet. So, as it says on the next slide here assets, liabilities, equity or kind of your main sections. And we talked a lot about that in the early kind of accounting one a one. So hopefully now, um, that was the point of that section was to get you to this point where now we don't have to talk about what is an asset. We know that that's what the company owns with company owes on what's left over for shareholders. So now we're talking more about how to present this information on a report. Eso Each section is broken down into more details. So in here and again, you look at the example, you'll see it, but they'll be cash accounts receivable. Here they'll be accounts payable, and maybe a note payable here will become stock retained earnings a pick. All the things we talked about more details and some. So the level of detail depends on the audience. SEC reports have very specific guidelines on what needs to be shown, and it has a lot to do with the values of these. You want to show major items. You don't just want a group. You don't just want to line this as current assets and nobody knows what makes that up. You want to break out cash, cancer? Sealable. That's that truck internal reporting. It's completely up to management. I'm always a fan of the more detail, the better unless the detail level ISS so onerous that it doesn't make any sense. But for the most part, I think I've never seen a company where you could just print off a detailed balance sheet and it be too much. So you would see every single break out of account these air General Ledger accounts remember, broken out so I would encourage you internal A for your own purposes. Toe look. A detailed balance sheet on the rule of thumb is just what makes sense. What's your goal in this? If you just want a quick look at what your total assets are, you don't need the detail. But if you're trying to do some analysis and see where things have grown, you want the level of detail. So a few more tips when you're kind of preparing a balance sheet you're looking at one don't use sense round to the nearest dollar. It's a detail. It's just not worth that. It just takes up more space. This is already fairly cluttered. You can tell when you start adding lots of numbers, so get rid of the sense in just round numbers off when it's large enough companies around to the nearest 1000 and they'll right up here as well in thousands. So instead of you know, $100 million they'll just acts the last three zeros. But they have to do that consistently, obviously, for each each column prepare this report on a monthly basis. I encourage you with all these financial reports to look at these every month. It's easy to just get tied up in your business. Things were going great. There's cash in the bank. Who cares how this looks? You can learn a lot when we get to Financial announced this. You'll see about doing a lot of ratios on this information will highlight areas of trouble or things you're doing well, and you can use that information to continue to grow your business. So I think it's an important part, and you want to do that on a monthly basis. So read the port report and once you're done, views that information. So again, look at things and you go airs Really climbing. If you just looked at a are and you know it's a $1,000,000 terrific people. Oh, it's a $1,000,000. But if you saw that was only 500 here it is growing substantially. That's money you need to start collecting on need to maybe be a bit more aggressive with your accounts receivable. So it's information like that that I encourage you to use, um, again, Look at the sample balance sheet for a full blown thing. I don't want to get that two in detail, and now, but you'll see this same format used. But but But Huck? Uh, so with that said, take a look at the sample balance sheet. You'll see this same format when in more detail, um, if you have any questions, let me know, and certainly now you kind of have an understanding of the layout of what a balance you should look like 17. Fin Stmt Prep Income Statement Preparation: next, we're gonna talk about the Inco statement and how to prepare an income statement in just some sort of high level things. So some of the same rules apply that we talked about for the balance sheets. The county software will create all the financial reports needed. You give it the certain specifications you can say it to compare it to previous period. It will do that. Um, so you normally present on income statement for the current quarter and year to date. So, um, for example, and again, we're talking more about a public company. Internally can do what you want, but you might say it's September 30th so we'll do the full Let's just write it out. It's excellent Z company income statement, and then it will say, for the three and nine months ending September 30th and then it might have a comma. And then what it will have in 2012 2011. And actually, it will have two sets of comes 2011. So this would actually be more here. This centered over the report, so this would be three months, nine months. So again, this is the current quarter. This is the year to date for September, so this would be nine months, three months. The reason they do that again, this is all about giving shareholders information that they need. If they just looked at the three months, maybe something great happened in these three months and they would see that, and that's terrific. But the point isn't to mislead shareholders. It's always give people a fair and accurate portrayal the business. So you would compare the year to date to the previous year to date, so you can see if there's actual growth on a yearly basis, not just on the quarterly basis. So for the header, we already kind of wrote it out. Company name, income statement for the X months. And it, um, audited or unaudited might be denoted on here is, well again, kind of above in here if needed. So in the body of the income statement over here, then we would have revenue, hogs, growth, profit. Let's follow what we have here. Operating expenses which might then be broken down into selling, um are indeed Guiana and then a total. And then lastly, we have other expenses and income and then lastly, we have net income So these obviously go all the way across. So again you have in your gravity. I think we've hopefully the cell rings a bell, which did it before your revenue. Your direct, your costs, a good soul, which we've added up through a cost accounting. We have a gross profit. Then we look at all of our expenses. And again, I saw selling R and D and G and A, and then each of those would then be broken out as well. Depends on sure we'll get to it. The level of detail will depend on get on your audience the same. It's the balance sheet. Either. You just have these three summarize, which typically would on SEC report. Um, internally, though you might look at each of these individually, each line item, broken out salaries, bonuses, healthcare, all those things, other operating income inexpensively, things like your depreciation or amortization, your bank interests, whether it's earned or you paid it income taxes and then the last to come to your net income. Then, as it says here, SEC reports have specific requirements. Depending on the materiality of these, you couldn't just have one line that says expenses. You need to add some level of detail is based on the level of how big the numbers are. So if selling is a big pirate, if I want to use a big part, you break those out, Um, and then internally, do what you like some some additional sense. Our tips. Sorry, don't use the sense again. Same tape you're tryingto. This is obviously even a bigger reports. So you want to condense this as much as you can. And there's no value in adding the sense to your dollar amounts when the numbers are large enough round to the nearest 1000 but did note it on the report, so people know what they're looking at. I always think that's tricky. When I see about she and it says like $1000 I think they only have 1000 within. Somewhere up here, you see in 1000 Zoran hundreds of thousands, and it makes a bit more sense. Um, again, prepare this on a monthly basis, So this is probably your key primary financial report that everybody looks at everyone. How much money did we make? What's their bottom line? This is the report that's going to give you that information again. Read the report once you're done. So it's one thing to just assemble this and printed out. Um, but it's one thing. But then to take that information and use it and try to figure some information out, like, Why? Why did sales go up here? But on the year to date, they're still down. Things like that. Once you get into this, believe me, there'll be 20 easy questions that just stand out alone. And then I want to mention as well I mentioned before how companies well export a trial balance to excel them, build their own reports. It's things like this, these air bit more tougher to build in your accounting software. You might be able to run this report and this report separately. Um, but it's difficult to design a report that does all of this and properly squishes down and condenses categories. So that's why companies just export their information to excel, and then they can build this or have somebody build it for them. Um, that's fairly very, very standard. I don't think I've ever seen a public company not do that, Um, and then you've comparative numbers for trend announced the self revenues were going up compared to the same. That's why you're comparing the three months ended here in here. If you're in a seasonal business, it would make sense that your saving a retail business your October November December is should be a lot higher than your other months. And that's why you compare that three months for the previous three months. It doesn't add as much value to compare the last quarter to the previous quarter. In retail business, you do want to see the growth, but you really want compared to the previous year. And have you did last year because that's more comparative with that, that's it. For the income statement again, look at the sample provided you'll see this but blown out much more. There's probably things on there that you don't We didn't discuss here, and that's OK. There's probably things like earnings per share at the bottom again, it's a public company. Everybody's finance reports are gonna be unique. Would be we would be here all day if I tried toe lay out every single thing you might see on somebody's income statement. But what you should see are these major categories and why I chose the company that I did for the sample is they have both software sales and service revenues. So way back and accounting one No. One. We talked a lot about, um, those two types of revenue streams, and that company actually has it, so I think that's interesting example for people to look at. 18. Fin Stmt Prep Statement of Cash Flows: next, we'll talk about the statement of cash flows. So now we're getting to kind of financial reports they might not be familiar with. If I had to say there was to financial reports that are the primary ones, it would be the balance sheet in the income statement. And then, when he expanded to three cash statement, cash flows would be the next one. That's level of importance, their all important, and I think altogether is where you really get the full picture. But I recognize, too, that people don't have all day to sit around reading financial reports every day. So, um, but I want to walk you through what the statement is and kind of the end zone ounce of it as well, just to, you know, um, and it is very important, especially in a start up environment where typically caches is tight and you're you're very carefully managing your cash, but you're saying you have to spend a lot of money to ramp up your operations. Statement of cash flows might be a good statement for you to understand a little bit, just cause it really details where your cash came in and out so thinking back before we get to the sides. Your balance sheet only shows cash like it shows you're ending cash balance, but it doesn't tell you where the money was spent on example. I always like to use is so we're gonna talk about a balance sheet for a second. Say it December 31st. This is 2012. This is 2011 same period. So stay here. You had a $1,000,000 here you had for a simple example. Say, here you had a $1,000,000 as well. If you were just to look at this, you go. What? We did nothing during the year. But that's not necessarily case. Maybe in this time period, you raise $10 million. You got a lawsuit claim you brought another five million. You were sued. You lost eight. You bought a bunch of inventory for two million. You bought some fixed. That's that's for more 1,000,000. Whatever the math is, at the end of the day, you ended up spending exactly the amount that you raised. So the net amount at the end of the year still a 1,000,000. You would know that looking at just the balance sheet, it's a statement of cash flow that's going to give us insight into all this other activity . So let's get into it. So same disclaimers. County software will help with the creation of this again. A lot of companies throw it out to excel just so they can manually make the report how they wanted to look and you could pretty it up as well. To be honest, just to make it look nicer than kind of a can report out of an accounting system. You look look at typically the present story, um, the current of prior year dates. So the nine months ended September 30th this year and last year. You don't really look a statement cash list as off the prior year. And, um, and again, you're looking for that comparison. So it's kind of the income statement you're looking for the nine months to the nine months you typically don't look at just the three months to the three months. And the reason is, um, you're I shouldn't say you don't A lot of companies will. For the most part, though, they don't. You already have enough information being thrown at you from the other financial reports you don't look at the three months. You just look at the year to date, so we'll focus on nine months and nine months. Same kind of logistics in terms of company X lies ICO statement of cash flows, cash flows, Um, as of whatever date, 9 30 actually, it's for the nine months ending cause you're really reflecting. It's again. It's like a video. It's all the activity that happened in that period. So as off, would you note that it's more of a snapshot like the balance sheet? So this would be for the period ending 9 30? Um, again, you might note that its audited or run out of it. So Stephen, a cash flows to talk about this for a little bit. Has three main sections operating, financing and investing. The method I'm going to show you is called the indirect method of cash flow. Um, it's the standard gap, and I haven't used the word gap that I don't think it's generally accepted accounting principles. It's what's recognized out there in the world. Not all companies use gap. Most use gap. Um, it's the recognized way of doing a statement. A cash flow is the indirect method. Just so you know what the direct method is, the direct method is kind of like a checkbook. You just start with your beginning cash. You show all the transaction that happened during the period. And here's your ending cash. That's why it's the direct method. It's fairly straightforward, isn't it? Problem is, it doesn't really group things that doesn't show you the ins and outs like nicely compiled . What the indirect method take attempts to do is take your beginning income statement balance. We're gonna walk through this and then reconcile it down to your beginning cash in your ending cash so it shows more of the activity and it's gonna group it based on operations, financing and activities. Um, and it looks to really show that change in things. So, for example, if your accounts payable went up or your accounts receivable went up, we're looking to show that change. Whereas you wouldn't see that on the direct path of the direct method is just here's cash that went out or came in. This indirect method attempts to show things that are non cash as well and how they impacted your cash. We'll get to it an example? Um, operations is typically the main section on the castle. It's where the most activity is. So, um, so what you start with is your net income for the period the nine months. So it's here, then you have changes. Triangle denotes the change changes due to operations ops and then financing. And then, um, investing down here, we'll have our beginning cash changes in cash and been cash before we get too far with ending cash number could be tied back to your balance sheet. So this statement it's direct link to another financial statement is that number. If that number doesn't match the cash on your balance sheets, something's out of whack. It means you haven't reflected everything on here. Um, again, if using county software should match up, But if you're doing this on manually and excel, you know that something is mismatch. So that's a good check. A swell, um, start with your net income changes, dude Operations. So Well, let's go through the slide before we get too far in this. So each section is broken down in more detail. Obviously, we're gonna go through what's included in here. Um, SEC reports have more requirements again, you have to show things that are material. You can just summarize internal reports. You could do this however you want. You want to rearrange things. He wanted to do the direct method. You certainly could. I think it's good to put this in practice and do it since you have to do it. A. Some point when you grow to large scale comes cos somebody's gonna want to see it in this format. And the rule of thumb again is whatever makes sense. Um, let's go through the additional tips that I'm gonna walk you through this So don't you sense again, large numbers were going around to 1000. Prepare on a monthly basis again for that information, if not, at least on a quarterly basis. Read the report. Once you're done, look at this and understand what it means. Don't just do it for the sake of doing it and giving it to somebody and saying, Look, I did a statement of cash flows actually learn what what it means on and use the comparative numbers to do trend analysis. So with that said, again you can refer to the example is well a statement of cash flows for B Square. You'll see this and you'll see a lot more detail that we're gonna use. But it be the same format. So changes dude operations. So operations of things like changes in accounts payable, accounts receivable, um, depreciation, things like that. All those operational expenses and things on the balance sheet you can think of as a statement of cash flow operation operational items. So I'm just gonna walk you through a few simple ones just to give you a picture. Um, so let's think on a high level three. If you have accounts payable on your balance sheet, that's money that you owed. Other people suffer you as of state. Last year you owed a $1,000,000 to people, and now you owe $2 million. In one sense, that's a bad thing. You a lot more money. But for the same cash flows, it's a good thing. Why is it a good thing? That's money that you didn't put out the door. Um, you wrote a 1,000,000. Now you owe two million. If you had paid all those people, that would have been catch going out the door. But it wasn't so you've managed to conserve that cash. So that's a positive impact on their statement of cash flow increases in accounts payable. Conversely, accounts receivable some money. You owe our money that's owed to you on, and I think you should know where this is going. But if that grows, the more of them people owe you. It's a bad thing. That's cash that you should be collecting. But you're not. So it's a It's a negative impact on your cash flow, and it's a negative impact on here. And what we show is the Delta between the last period and the current period, Um, and how that and how that has changed. And the way you do that is it's linked to your balance sheet and again. That's why once you kind of link up each line item in the balance sheet and how it changed and how it impacted your cash, that factored in with your statement and income, then links back to your balance sheet, and that kind of creates this full circle with your financial statements. Um, that's just two examples here. Um, if you had money that came in through, so keep in mind we start with her net income. So this reflects already all your revenues. Your COGSA expensive. All that's built into your net income number on. And remember, this number also goes to the balance sheet as retained earnings so again creates an additional link. Um, but there's a few things on your net income Internet incumbent aren't cash related. So depreciation is the one I mentioned. Appreciation is a non cash expense, and we talked about appreciation fairly extensively before and fixed assets. So you want to back that out? So now we're trying to reconcile not only what changes happen, accounts receivable, accounts payable when any expenses that are built in that really don't have an impact on cash and never will. Depreciation is one so depreciation, there's another ad back. You add this back, so be recognized $100 in depreciation expense, you would add it back down here changed in appreciation again. You're trying to back out all those expenses that will never result in cash flow, whereas salaries you do actually pay salary. So that was cash out the door. So that makes sense to leave your salary expense in here. Um, I'm not gonna write all these out because it will get fairly lengthy. But that's just an idea of the things that happened in the operation section. The other two sections air a little bit more simple. Um um, financing is more is things like people invest money in your company, received money for stock people. You take out a loan, things like that. Like what? So those would be increases in cash. Likewise, if you paid back alone, you buy back shares to pay a dividend. Decreases in cash, so decrease here for your financing section. Investing Isn't you investing in other companies? Investing is investing in your company, so it's things like buying fixed us. It's buying inventory, selling inventory selling fixed us. It's so obviously when you buy them, it's a decrease to cash. Remember what this is kind of backwards, and when you buy an asset, it's a positive for your balance sheet. Your bolstering your balance sheet. But it's a negative to your cash list. That's a negative on here. Um, we buy inventory by fixed assets, But then, when you sell that inventory, if your net changing inventory was a decrease, um, that means you put out more inventory during the period. Um, then you bought so it would actually be a positive impact on here. End of the day. You add up all your transactions, Um, you come up with a total here, you're beginning cash, you're changing caches. All this kind of adjustments and your end in cash. And then again, you should be able to then tied at number two, your balance sheet. So that's the statement of cash flows in general a little bit more confusing, maybe, than the other statements. It's definitely takes going through preparing a few of them to really grasp this method. It's kind of contrary to just the direct method where you just list out the ins and outs and come up with some numbers. Um, once you understand how toe one put this together and then 200 read and use this information. Um, I think it's important, especially when you look at things like accounts receivable, accounts payable. You see the change and how it impacted your cash. And it's good. And like I mentioned, we have that $1,000,000 in cash before it looked like it didn't change. But don't we look at this. We see all the ins and outs of the cash law where it went, and then you have a far better understanding after looking at your statement of cash flows . 19. Fin Stmt Prep Statement of Equity Preparation: next, we're gonna talk about thes statement of equity. It's not a common report that's used. If anything, this is probably most ignored. Even the SEC doesn't requirement on ongoing basis. It's just an annual basis that a company would prepare the statement of equity so you won't see it often. There is a sample included in Europe in the downloadable statements for Be Square. So all the same applies here accounting software can generate this. We're gonna round when thousands, if it makes sense, don't include sense things like that. And then most important, is to use the information to actually make decisions once it's done. So what the statement of equity does. It's the same kind of headings. You know, statement of equity. Uh, for the nine months and since this one's usually done an annual basis, will say Ex likes why So the way it's prepared us again, it's to give you more information on that equity section. Remember, on your balance sheet, it just shows common stock preferred stock, a pick retained earnings, maybe Treasury stock, and that's about it. So this is to give you more of the transactions that happened, and they in the in the period in the 12 months, so across the top first you'll have your sections kind of list. It's a common stock preferred APEC retained earnings and then some totals. Then what this attempts to dio is show the different types of transactions and how they impacted each of these numbers during the period. So maybe you issued stock for services. It was to stock for services and as well the common stock and preferred stock will be broken down between the number of shares and the dollar value. So obviously, the number shares isn't totaled across, but it's there for your information. So maybe you issued 100 shares for $1000 worth of services. Another would be nothing Here, Um, maybe some investors you issued common stock for cash you issued, um, so thinking back to our transaction say we had a dollar par, but somebody paid $5 per share, and they give you $5000. Um, so 1000 would go to here for the 1000 shares, but they paid you 5000. There's an additional 4000 in a pick for a total would be five K totaled one k. So we show we issued 1000 shares. We have $1000 par value. 4000 went to the additional paid in capital in the total we received was 5000. So, again, this gives you that bigger picture on the actual transactions that happened. Um, other things you might see is options issued warrants, changes in exchange rates. If you're an international company, changes in exchange rate and each of these goes across and shows how it impacts each of these categories in your equity section. Um, the last thing will be like your net loss or your net income net income. Be positive that would go to your retained earnings. It was $10 or $1000. That would be over here along with all your other things. At the end of the day, you can total this. You can total it this way, and you can total it this way so they'll be totals down here as well for each of these categories and then this total ties to your balance sheet total equity. This is good because you're able to see So the totals down here you'd see oh, are common stock should have increased by 2000 for the numbers we have up here, a pick 4000 but you can also total across and see what types of transactions impacted it and where it hit within the equity section. That's the point of this, Um, I think it's important again. It's not one that that's fairly standard and take some ticking tying to do it. Some accounting software doesn't even necessary produce this easily or quickly. Um, just cause all of this is fairly customized, so you would have to somehow denote this in your system and or for the system to know that your entry was for the sale of common stock versus for services. So it's a little bit tougher. This one typically is done manually. Um, at least you know what it is. That's the purpose of it is to give you a better understanding of your equity section in the transactions that flowed through it. Um, so with that, you've seen the kind of four primary financial statements those air the four that would be reported on an annual basis by publicly traded company again, the income statement balance sheet are gonna be your kind of go to financial reports that you probably look at definitely every month. I encourage you to, Ah, statement of cash flows. I mean, encourage you look at all these but statement of cash flows and the statement of equity would be kind of your secondary reports, if you will. Um, probably only looking at this maybe on an annual basis, because they're not nestle a lot. You can do here other than maybe you say, Hey, we issued more stock than we would have liked things like that. But you make more operational decisions based on the balance sheet and piano. So without we've walked through all the financial statements again, look at the sample. It's a public company. You could go look, I pulled that sample from their 10-K report for 2011. I believe, um, that belongs to a full 10-K And what a 10-K is. Just for your own information is the annual report that companies file so publicly. Traded companies file a 10-K report has a wealth of information about the company of which part of it is the financial statements. So that's where you would find these embedded. So with that, hopefully you have a better understanding of the financial statements, their purposes, how toe kind of what to include in each of them, and we'll move on to the next section. 20. Analyzing Fin Stmts Balance Sheet Analysis: now that we've learned about each of the financial statements and kind of had a preparing, let's talk a little bit in this section about how to analyze the financial statements. So I made a few references to the real value in your financial statements is comparing them to previous periods and seeing how the company is performed. Since then, there's a lot of value in looking at an income statement and seeing how did we do last year compared to this year versus just looking at this year and seeing how you did so First of all, just some general information. We have started talking about the balance sheet. Then we're gonna go through a nen come statement of cash flow statement as well and then a Z one of the downloads for this section. There's a full list of ratios they can use, so I encourage you to download that we're not gonna talk about each of those. But those are very standard kind of analysis ratios that companies use accountants usedto to determine the performance of a company. Um, so let's just go through the sides, starting with eso. Balance sheets often ignored and focus the main focus on the income statement. I think operational. That's what you see nine times out of 10. So I encourage you to also pay attention to your balance sheet when looking at gleaming information from them. So there's a wealth of information. They're actually one audit firm I used to work with. They would start with the balance sheet. They would go to the balance sheet and see changes in it before they would jump into the P nL because they felt like the balance sheet really told the story about whether the company grew or didn't grow. Um, the bounce. She tells the story about the business fundamentals, like, How strong is it? How much how many assets doesn't have, how much does it? Oh, and what's left door for everybody else is kind of the the name of the game when it comes to the balance sheet. And again, just keep in mind the balance sheets like a snapshot. So it's as of a specific date. It doesn't reflect trends, actions that happened during the year, whereas our other financial statements do so let's just go through each of the sections, kind of a quick refresher on some of them and then how we're going to use them and how they should be viewed. So so talking about assets, we know that assets are what the company owns. So liquid assets Air favored the long term assets. They could be used to pay off debts. So again, we're thinking like an analyst now, if you will, or in terms of performance. A liquid asset would be preferred to a long term asset because it can quickly be used receivables. Air kind of liquid there definitely classified as a current asset that can be turned into cash. Um, but they're not cash in the bank. You couldn't turn around user receivable tomorrow to pay a bill. Inventory could be good and bad. Ah, high inventory balance means you're you know you're loading up. You have stuff to sell. But it might also mean that that's obsolete inventory that's just been sitting around. Hard to say, and it's not something you can quickly turn into cash. But again, at the same time, if your inventory has been beefing up, it might be an indicator indicative of sales to come or just growing sales in general. So you have to know that yourself. And then, as I mentioned, the higher your inventory. That's cash that's tied up in inventory. So depends on the situation. Might be good. It might be bad, Um, thinking now about more long term assets of fixed assets are necessary to run the business . So when you see fixed assets growing, it's usually a good sign for a company. Typically, not too much done is done on the analysis front with assets other than you're looking for that growth, you're looking at how quickly their depreciating their ass. That's things like that. But assets really other than accumulating assets usually means growth. There's not a lot of performance analysis you can do on. Assets are long term asset. Intangible assets have little immediate value, so we're talking again about patents copyrights that their value is in creating wealth for your company. In the long term, you use that pattern or that copyright to generate revenues and build stuff that generates revenues. At the same time, it's difficult to just turn around and sell a patent. It can be done, but it's not. Ah, highly liquid asset thinking. Now the liability section So current liabilities Air due in the next 12 months. So the higher your current liabilities, you're gonna have to make sure that you have enough current assets to cover those. And that's when the ratios we will talk about typically accounts payable, um, their near term payroll expenses. The Krul's anything current liability wise. You're gonna want to make sure you're able to pay off long term liabilities, such as like a loan. Bank loan reflects past financing, so it's money you receive in the past. You now owe it. They're going toe it over some period of time. Um, the announces that's done on this is typically, how leveraged are you? If you borrowed and borrowed and borrowed and you're continually borrowing and your debts just growing, that's a bad sign. If you borrowed in the past and you've grown the company since and you're paying that debt off, that's a pretty good thing. And then I mentioned the word leverage. Leverage just means you have a lot of debt and the more debt you have relative to your assets in your equity. And if that number is growing, that's a bad thing. And that's again, where it's hard to just look at numbers and say, Oh, well, the number went up. You know, maybe we took out next year 1,000,000 in debt. But if your equity also jumped up substantially, maybe it's because your company is really taking off your growing quickly. So you needed that extra 1,000,000 in debt to finance additional growth and inventory of stuff, so you can have to look at the ratios to kind of normalize these numbers. I will get to the ratios, Um, so the equity section obviously represents the stakeholders own on the business. Retained earnings tells you the profit, since the company company since inception, again members. Sometimes they break that out like current net income and retained earnings from all other years You've just combined those two come up with the total amount that companies made or lost and where we give us. The equity section is comparing the equity to the debt to give a on idea of how how highly the company has leveraged. And again, that's one of the ratios that we talked about. So let's go through a few of the ratios. So in the downloads I mentioned, um, there's all kinds of ratios where it's going to go through some of the important ones. I'll say if you only have time for a few, use the ones that we talk about right now, um, so current ratio. So each of these kind of has their own name as well, so the current ratio is current assets over current liabilities. Very simple, I think. You know, if you think about it, it does the business have enough liquid assets to cover its near term liabilities? So say we did This ratio was right it out. So our current ratio so equals current assets. Or let's just say assets over liability is just a right out and say it worked out to 2.1. We have 2.1 times the amount of assets that we do liabilities, current assets, current liabilities For each of these ratios, there's kind of a standard industry norm. That's kind of the acceptable number, and you'd have to lift these up for your industry and fridge ratio. What's kind of the appropriate number I can tell you that to the three times is a healthy ratio for this one. It's one I know of top of my head. If you have two times the amount of assets and liabilities, you could pay off all your liabilities and still have liquid assets. Current assets available where you're really in trouble is, if this was less than one, you have less assets than you do liability. So if you have to pay every liability, wouldn't even have enough assets to pay these. And that includes your current assets, things like inventory, things that aren't even necessary liquid. That's why something like a two to a three ratio is good because not only your assets are necessarily liquid, either. Um, the fundamental point here I want to make with ratio analysis is that it's the comparison against Let's say you came up with a ratio of 2.5. That seems pretty good, right? But I want you to look back. I want you to look at previous years, So if the ratio was 3.53 point seven now, we're not quite as excited about the 2.5 because of dwindling. There's something happening here, so that's when you want to not only just look at a number and say well, that's a good ratio, Chris said. 2.5 is a good ratio. Look at the trend for your business and see if it actually is a good thing. And if it's not, figure out what's happening here. Are your liabilities increasing? Is your assets decreasing? Either of those? Could be a change is just a mix. What's the business reason behind that? Not just like don't just speak in terms of assets and liabilities. What's actually happening? Are you not collecting cash? Are you borrowing money? Whatever the case might be, um, quick ratio is similar to this, except it does only look at your liquid kind of assets. So not only your current assets, but you eliminate things like inventory. So you only look at cash and receivables, which could quickly be turned into cash. There's ways to pledge your receivables and receive cash from third party companies. You receive a bit of a discount, but you could get cash on them, Um, on Let's and let's it So occurred a quick ratio you're looking. It's a bit more restrictive in that you're kind of diminishing. How much? Asked, if you have something, numbers will typically be lower, but you definitely still want to be over that. Number one because if you have less assets and liabilities, you're gonna run into a problem. Let's talk a little bit about leverage on, and I kind of mentioned this a little bit already. So leverage ratios your liabilities over your equity, So I kind of conveys how much your businesses relying on debt to fund the business. So the lower the better. Um, the reason being is that debt is something you have to pay back, whereas equity, if people are investing money in your company. Sure, people like to be paid out, but there's no guarantee of it, whereas with alone you do have to pay that at some point, and it's gonna be interest on it. The hope with equities people invest. The money sits for years, you build a company, those shares are worth more, and you can buy them out at the end. Um, it's not to say that all debt is bad. Sometimes it's necessary to get the business going, and sometimes you just don't want to give up equity. You don't want to give up control of your business, so you issue debt and you take on those loans knowing you could pay them back in the year two. But what that debt? I won't read it out. It's on this side here. Liabilities over equity. I don't know what a fair number is, and it's really depends on your industry for this one and what's kind of the norm. Some industries used debt fairly extensively to borrow when they're constantly repaying and constantly borrowing more money where its other industries would rather just have no debt. So there's no kind of standard ratio here that that's good. Um, but find out what it is for your industry. Um, there's other ratios which combined balance sheet numbers along with the income statement in the next lecture, where we talk about the income statement, I'll show you some of those. So we'll reference back to the balance sheet for some of them. It's gonna be things like turn on accounts receivable. Turn on inventory eternal Next assets equity, things like that again referred to the sample that came with the section will be far more ratios that you can look at and again. I think the most important take away from this section is besides just doing the mechanics of calculate ratios. Compare them the prior periods and then use those as the indicators because some might turn out to be the same and you go great, there's no problem. Others their declining. And you say OK, that's what we need to key in on. Let's look at those. And once you kind of work out a full sort of suite of ratios for your business, you then just monitor earth. Um, and you're looking for indications for ups and downs. 21. Analyzing Fin Stmts Income Statement Analysis: next, we're gonna talk about financial analysis on your income statement. Your P and L will do the same kind of format, will just kind of walk through a P and L in the different sections. Then we'll get into some of the ratios there. Certainly more ratios, I think, related to the P and L because they can. Really. You look a performance on the P and L and as well related to other financial statements like the balance sheets. So we'll go through that again. The sample that's provided provides a whole list of ratios you could calculate, So I encourage you to look at that. Um, as it says, the income statements those utilize financial. Remember the income statements like a video so covers a period of time, um, and indicators from the ratio announces help management make informed decisions. So that's why we go through this exercise. So thinking of revenue again, so growing revenues is a preferred trend. I hope that goes without saying. If you see revenue continually growing, that's a good indicator. If you see it dwindling might be a problem. Sure, there's lots of reasons. Maybe you got rid of Ah, uh product line that wasn't performing well so that would decrease your revenues but might help in other ways, whatever the case might be. And I think in general, growing revenue year over year is a good sign. Um, revenue should also correlate to events. So, for example, you interest introduced a new product line. You should expect to see your revenues grow, um, revenues by product and service line, or what important for trend analysis areas, air growing or not growing so again, you don't just want to look at revenue is an entire bucket. You want to break that out. Andi certainly could break it out by product. And and most companies will the more proxy have. You're looking at each product and how profitable it is, etcetera. And you want to do that analysis for purposes of just doing kind of an income statement analysis will just group it together. It's wrapping you the cost of revenues, reminders to cost directly associated with the revenue that's generated. And we already figured out how to create a cost of goods sold for our widget. So typically, these costs should move in tandem with revenues, revenues, increase your cost of goods sold will increase. And then you can look at things like gross profit, which is kind of our first ratio, if you will, that's on here. Is revenue less your dogs? Um, colleagues or cost? Cost of sales equals your gross profit, and then you take your gross profit divided by a revenue that's your gross profit percentage. So again, if you had 100 revenues 30 in cost of goods sold, you had 70 and gross profit 70 over 100 is 70% so you have a 70% gross profit ratio. Um, there was an early example. I did where revenues were growing, but then the gross profit ratio declined. And that's where you want. Start asking questions again like Why did it decline? Are we giving more discounts? Are did we hire better staff? We have to pay them or, um, and that's why our gross profits declined. But we're getting mawr dollar wise. Things like that are questions that come up expenses, so there should be no express surprises when it comes to expenses. When you look at expenses, you should have known in advance how they might play out. So you're looking for large variances, not small dollar amounts and not small percentage changes. If again, if you're looking at a full list of expense categories key and on those big dollar items and big variances, Um, and hopefully you knew about what the big variances we're gonna be. So some expenses air directly tied to revenue or fairly closely, so an increase in sales happens because of a larger sales force. You're going to see a larger sales and marketing line item on your income statement, so it's not always you increase revenue and it just all the rest is the same. There's a lot of costs that you called variable costs that vary with the amount of revenue in the mount yourself. So things like your your staff would be kind of a step type thing. You have to hire a staff hire staff, but you don't continually hire staff, but it does. Increases revenues increase, so whatever the movement is between expenses, revenues between prior periods find out what the story is. That's what you're most interested in. Let's talk about a few ratios now, so we talked about gross profit percentage. It's your gross profit, divided by a revenue that's fairly standard, and a lot of companies will even show that on their financial reports. It's important enough that they want to see and they want to track it. Kind of all these other ratios or most of them are kind of done, almost a on the side. But they're not part of the primary financial statements and work that's done you have. You might have someone who's devoted their entire job is financial analysis. Um, net profit percentage will be your net income so that bottom line divided by your revenue. So it's after all the other expenses. How did the company perform? And again, the real value is comparing that to prior periods. How do we compare this year to last year? Are we growing? Are we're not growing sure dollars might have increased, but maybe our net income percentage decreased. Next formula is inventory turnover, so now we're tying together the balance sheet and the income statement. So inventory turn is your net sales. You take all of your sales divided by your average inventory costs. Whatever your inventory balance was saying, the, um, beginning of the year in the end of the year, you average that number on the net sales divided by that average number. It gives you some figure. So to see is an example. Say your sales were one million. You're beginning inventory Waas. Let's say with zero, you started off and then you're ending. Inventory was one million. The average of this is 500,000. So here's your sales. This is your revenue. Will this kind of on the side? Here's your average inventories were in divide by 500 K and we all know that equals two. That means you turned your inventory over two times. So you made a 1,000,000 in sales. Your average inventory balance on your balance sheet with 500 k So you went through kind of to inventory cycles. So it represents how, while you're managing your inventory so the more it's turned, obviously the better because it means you're, um, generating more sales. Because if this was two million in your average inventory was 500 K That means you're continually generating it. Imagine list with 10 million and you still have this dynamic. That means that you generate 10 million in sales, which means that I mean for 10 million sales toe happen. There had to be a lot of activity on your inventory line. You just don't see it cause you're only looking at the beginning and ending balances. But there was a lot of buying and selling, buying and selling. And that's what this number is trying to reflect so again, when you compare that number to previous periods, or maybe your forecast for future periods, that's where the real value issue see what your turn is and if it's getting better, worse and obviously the more turned, the better accounts receivable. Turnover. Um, similar kind of concept. So accounts receivable from the balance sheet divided by your days credit sale. So days credit sales attempts to take. So not just revenue. But you look at what sales were made on credit, meaning what went to accounts receivable. So you kind of key in on those revenues which were only accounts receivable impacted, which in a lot of cases is 100%. But in some cases, maybe you're in a retail business where you you take cash and credit so you would eliminate the cash. Ones were focused just on the credit, and you're looking again to see how quickly you turn accounts receivable. So if your accounts receivable balance at the end of the year, let's just use the same numbers. Was one million your average credit sales? Probably on a daily basis. One of 500,000. Let's assume it. WAAS. That means you're turning your accounts receivable two times. So the bigger the number, um, it reflects how quickly air, uh, collecting on your accounts receivable. So the faster the better, and you're looking for improvements. Um, you're trying to again, the more you can turn your accounts receivable the better, because that means you're getting new sales. Your collecting. I'm getting new sales. Your collecting them. If this number is low, it means you're getting sales. Not collecting, but getting more sales. Not collecting on That's not what you want. Return on assets again. Time together, Income statement and balance sheet s a return on assets. Is your net profit before tax? You might use your even don number. If you remember, that's earnings before income tax depreciation amortization would be a good number to use on divide that by total assets. So the ratios looking to show how well the company utilizes its assets generating come this one. People use kind of where applicable cause In some industries, you just have assets. If you're in a start up environment, you just have computers and deaths and stuff there just kind of necessary. You're not really buying another computer isn't gonna help you sell more of your product, whereas in a manufacturing environment, buying new equipment, buying updated equipment might help you sell equipment, our story, sell more product or generate profit more quickly. Maybe you can run more units. You run more shifts in your factory. That's the situation where return on assets probably makes a bit more sense. Um, lower than average compared to the industry's means. Companies not being efficient. So this is another one where you can look at your specific industry and with standard ratios are and see how well you're performing compared to those and anybody can find those kind of standards out there. Just go on the Internet search, return on investment. So this is probably something you've heard of A regardless of accounting and finance just in the world in general. The return on your investment. So in accounting sense, its net profit before tax. Let's use EBITA divided by your net worth and net worth, is your equity. So how effective is the company of generating profits from the capital that's invested? Now we're looking at. Well, there's two million invested and we only turned one million of profit, and that's a great But if it was two million invested, we turn 100 million of profit. Okay, so we're using that equity to generate wealth. So if the return is less than the lower other low risk alternatives, the business might need to reconsider. So again, used examples say, um, there's 10 million in equity and we're only turning a consistent return on equity of, um, not even a 1,000,000 were only generate, like, 100,000. It's a pretty low return, and if that's consistent and it's not growing, that means we're not way had a bunch of money invested in us, and we're just not able to make sales happen. Um, what this is referencing is low, other low risk alternatives. So your return ended up being 1% on your equity. Somebody could go the bank and put the money in the savings account. Maybe not these days, but they could park it somewhere. Maybe in a CD. Returned 2%. 3%. Um, if you could do that, that's a better use of the money. So you don't want to see ratios where it is 1% half a percent. You want to see that people are using their equity, Um, and earning money on it. Sure, it may still be low, but it's better than some a lot on other alternative, like investing in government T bills. Some additional ratio announced this information. So imagine often custom designed ratios. So we talked about some very standard ones, and there's some more standard ones on the sample. Um, every industry is unique, so a lot of times companies will look at what it is they do unique, and they and they just figure out they figure out what their pain points are. And they say I want to understand better this ratio, Um, and they implement their own custom ratios, which is totally fine, because this is all internal reporting. This isn't stuff that you report to the public. Um, and ratios are only effective when used, so you can do the math all day long. But if you don't then take the results and compare it to previous periods. Compared to industry norms, it doesn't mean anything, so I definitely encourage you to take both steps on both, prepare the ratios and then compare them and get some information out of it. So with that, that's ratio analysis for an income statement. Last, we'll talk about statement of cash flow where there's actually not as many ratios on that will be it. You'll have a good idea then of how to take financial statements, not only prepare them from the last section, but how to look at them. Read them and do some analysis on them now. So you can really get a lot information about your business, your competitors business, whatever the case might be, um, and use that information making important business decisions. 22. Analyzing Fin Stmts Statement of Cash Flow Analysis: So in this last lecture, we're gonna talk about the statement of cash flows and how to use it in analysis. Just some general information. First, it's the least suits financial statement for ratio analysis. I think you see most things calculated off the income statement. In the balance sheet, cash flows less about how the business performed and more about how it utilizes cash where the cash came from. So it's I don't want to say it's not as important, but it's definitely out of the three. I would focus on the other two first, but there's definitely some things you can do with the cash flow statement. As it says, useful information can be taken from it. So the primary section of most cash flow statements is the cash flows from operating activities. Let's just kind of walk through the cash flow statement again. We prepared it in the last section. Now let's kind of think about it again. We talked about the indirect method. It starts with net income, adds into ducks, non cash expenses and as well as changes in the balance sheet. Accounts receivable went up, accounts payable went down those air reflective of how cash was managed. Eso increases in liabilities are good in theory, on the statement of cash flow, it's money that you didn't put out your accounts payable went up. It's because you didn't pay your bills. Sounds bad, but it means that that's cash that you kept in the bank come from an investor's perspective . Um, they like to see high cash balances that ends of periods the end of the year. The more cash that's in the bank, the better. Even if there's an offsetting liability, it's just better to show one million in cash and one million accounts payable than zero cash and zero liabilities, because with the cash you have flexibilities, if something came up, you need to buy inventory. You have options with that cash, whereas if you just paid off your liability, sure, they're gone. But now I have no options because they have no cash. Um, as it says, cash is conserved. Eso accounts payable increases means that cash and go out the door. So I think we have that now. So decreases in assets are are also good. So other than cash, less aside from cash accounts receivable goes down. That means cash was collected, and now it's in the bank. So yeah, your accounts receivable that goes down while you had increasing revenues. Terrific story. That means you're bringing the money in and you're turning it faster. So look as well for big ticket items than figure out the story behind what happened with the money. You know, every line on the balance sheet is gonna change over a period, but we're not too interested. Something only changed half a percentage compared to the prior period. Whereas if accounts receivable in cash changed drastically, those their stories that you want to figure out and be able to tell the cash flows from financing section on here Casual statement. So again, financing activities. Air typically taking out paying back loans, equity investments, its financing in your company. So whether these air, good or bad, just depends. You know, if you're a growing company, maybe receiving a bunch of money from loans was a good thing. You've been trying for a year to find the equity toe or the money of the capital to build your business, and you finally found it. So you have this huge injection of capital. Um, whereas in the future. You'll see that loan being paid off, and that will be a good thing when the loans decreasing. Um, funding depends. I mean, if it's a company that's already been funded now this is their fifth around the funding, and they're continually burning through funding every year. Is it good? Is it bad if it's getting them somewhere terrific? If it's just kind of prolonging the inevitable, then it's not so great. And you have to know that for yourself, what's right and what's wrong. Cash flow from investing activities. So again, investing activities means the business. Investing in itself through fixed assets through inventory are the usual examples I use. It's nothing to do with bonds or mutual funds. You're not investing in stock market things like that, Um, so it's cash put back in the business. Eso Growing companies will typically see heavy capital investments, a swells, heavy investments, an inventory. You'll see their inventory bounces building, so it's usually a sign of growth. So it's usually typically good thing again. It's all relative to what it is that you do and what stage of the business cycle you're in . So in terms of ratio analysis, there's no standard ratios really out there to analyze the cash flow statement. This is where a lot of companies will sort of take the liberties of developing their own things if they if they bother to. So they might look at cashews and operations relative to net income. They might look at caches and operations relative to total cash used, and then also cashews and financing and investing. And see what the mixes between those three. And then again, compare those over periods. Are we switching from or of using cash operations, tomb or investing in the business? That might be a positive indicator. If you looked at that ratio, um, again, Announcer should focus more on the trends and as well, look at the cash position. Is cash increasing or decreasing? And I think at the end of the day, that's what most management is interested in. But I find a casual statement, really use one. I think it's important to look through and see, see the ups and downs and where cash is going with that. That's the statement of cash flows and, uh, kind of quickly had a look at it and think about it again. I'd encourage you to take your own, um, stabat developing ratios if you think it's important. And if you're in a business that they use this a lot of cash and turns it maybe brings it in and spends it think about then better ways to utilize your cash and may be looking at statement of cash flows will give the ideas of Maybe you shouldn't be investing so much and fixed assets. Maybe you should be leasing things like that. Ideas like that spur when you start digging in the numbers and doing Simone of your own ratios to figure out, um, the performance of your business. 23. Audited Financials How to Hire an Audit Firm: in this next section, we're gonna talk a little bit about just audited financials. So as you kind of move along and grow your business a some point you're gonna want to start getting audited financials for a couple reasons. One they're required. When you go public, you're gonna have to have your financials audited. Um, the way it works is you typically get your financials audited a full audit on the annual basis, and then you have quarterly reviews and the reviews there just to kind of keep the otters up to date. Make sure you're on the right track. Fix any problems during the year. So the year end audit isn't as horrible. Before you go public, though, a lot of companies will get their financials audited regardless, just to make sure they're doing things right. They want some third party looking at them. Um, you're looking for possibly indications of fraud, which, unfortunately happens a lot these days, Um, things like that. But it's more about just making sure things are done right. If your goal is to go public, I will note that you'll need a couple years of audited financial, so it's better to get them done along the way, then get to the point where you want to go public and then say, 00 geez, we have to go back now on audit two years The financials it won't be fun will be fairly expensive things like that. So it's better to take care of it during the process. Um, certainly, if you're a super small business, you're probably not gonna be engaged in this, but you will get to the point where you do need audited financials. That's why why I want to walk you through this section and talk a little bit about auditors and how the process works. I spend as sort of an outsourced CFO. I spent a lot of time working with auditors. That's what my one of my function is. Gay moment. The information explaining transactions, the proper documentation explaining and showing the proper accounting for transactions that happen. Every company is unique, so the auditors have toe be flexible and understand different industries and different company sizes. But they also sometimes they help understanding why you did something one way versus another. So first, let's talk about how to hire an audit firm just to begin with, um so all auditors air not made equal. You have individual CPS who could be an auditor might have a large audit company. I've used Deloitte Touche. KPMG Moss Adams is one that comes to mind in the Pacific Northwest. Larger firms. The fees can range drastically on the qualifications may range drastically. Now they're all gonna be CPS and the people that come out or CPS Um, so I don't want you to think that that's part of the range ever is gonna be a C p A. But it's more about the experience they have. Maybe they focus specifically on your industry, Or maybe they don't. Maybe they focus on other industries, so they don't quite know yours as well. Um, as well you might, if you're a smaller company, might be better off with a smaller, um, auditing firm or an individual. The reason being kind of build that personal relationship, and they will get to know your business a lot better than a large audit firm. Where is what happens is they send out the new auditors, and then a year later, they send out other new auditors, so nobody really ever completely gets to be with you for years and years on then. So there's pros and cons to each. Fees can range drastically. Like I mentioned, I'm not sure if I talk about the fees I do on the next slide specifically about fees. The auditors aren't cheap. First of all, um, it would be hard pressed to find a cheap auditor. Typical engagement involves both the quarterly reviews and the year end audit. So you're looking at the whole picture for a smaller company. Ah, low end might be $10,000 per year high and my p 40 so that be for the whole engagement, all three reviews and the year end audit. But still you're looking at maybe $10,000 I don't think I've seen less than that. I know that one of my smaller clients pays six, pays $12,000 a year for their audit. Um, fees for larger companies only increase, and it's because there's more work. They're sending out more auditors. There's more transactions to review. There's more of a timing issue, so the fees only go up from there. So how to hire an auditor? There's always people out there. Maybe you at least have a sense of where you should be starting. You wanna individual versus a large company. So first, ask for referrals from other companies from friends. You know, if you're in the small business, start up world, you probably know other people and companies. Ask them, who do they use? Um, talk to the auditor. So So don't just focus on one. Get proposes formally. Say three auditors, talk to them, see how responsive they are. Do they actually ask questions? Are they interested in your business, or are they just looking for a new client themselves? Does their style match your culture? Are they laid back or they use it going. Are they more formal again? You tend to see with larger the company. So the large delighted to share something, um, will be a bit more formal. But if you're, you know, start up with a crazy office on that type of stuff. Maybe that order doesn't fit your culture as well. And you'd rather be with someone who kind of is adaptive and understands the start up world a bit better, and then pricing really a big part. You'll receive such a large range and pricing on your audit. It'll definitely be a fundamental factor and who you choose. And sometimes you get stuck in a situation where the people you want cost more than somebody else. And you have to make that decision. Do you want the people that you really, really want to work with, where you want to save the money and get the people who are maybe not as great a fit? But you know, we'll still do the job. Um, just maybe, be a bit tougher herself. What else to consider? If you're smaller company, will they make time for you? So if you're with a large company, you're kind of their bottom rung if you're a small company and they just want to get your audit done and out of the way, which you might want. But at the same time, scheduling might be an issue in that situation. Um, where's if you work with a smaller company? They're more flexible. They might be more aware of kind of your your needs as well. Do they have experience in your industry? I think is an important one, especially if you're in some unique industry or, say a new industry that's growing some type of you know. Think of the dot com, you know, certainly dot com that came along a year to later would rather work with a nodded firm that already went through the experience. And somebody who had never worked with a dot com before Sophie's are negotiable. Keep that in mind and use the competition between them to your advantage. So if you get a quote, that's higher. But you really want to work with those people. Tell them say, Hey, you know, we're leaning towards these guys only because of the fees we really want to work with you guys. Is there anything you can do? They probably could do something, um, and then learn about their auto process. For your own information. They probably will tell you more about it during presentations and the engagement process. But, um, just learned what it means. Like, are they going to be on site? Are they not? How long do they anticipate on it takes What sorts of things are they looking for? Do they send out one honor? They send out? Three. All those things learn about the process, and with that, that's auditors. In a nutshell. on how to hire them, things to think about, and then we'll talk a little bit more about the actual out of process in the next few lectures. 24. Audited Financials From the Auditors Perspective: next, we're gonna talk about auditors and kind of the audit process from their perspective. Um, As you might know, auditors kind of come in sometimes is a bit of a hassle for the company. They have to supply a lot of information of. The otters are eating up you and your employees time asking for requests, your explaining things. I think it's important, understand, from the auditor side the where, where they have to report to the report to internally within their own company. They have the PC, A or B. Who there responsible to so they can have their own check lists and guidelines I have to follow on. And if they don't do that, they can't issue the audit letters. So it's important that they follow their own guidelines as even though it might seem like a bit of a hassle for you. So just give you an idea so auditors have to meet the minimum requirements there. CPS, uh, they have to follow specified guidelines during their auto procedure. They have to be experts in all accounting rules because remember, they're dealing with companies and all different industries, all different accounting type of issues, things coming up. There's so many unique accounting things and specific things to each industry that you need accountants and unaudited or student who can know and understand Ercan. Read the literature and interpret it and make sure your accounting is properly reflecting it on that as well. They have to remain independent. So, for example, they can't take stock for payment because then they would have a vested interest in your company that won't fly. So there's those few quirks when it comes to auditors, a part of the reason they kind of have to be standoffish. So thinking of an honor if you've ever been through in on it, this stuff will ring true if it doesn't, um, it's very much true and probably even worse than your thinking. So, first of all, it's not fun to be an auditor. Junior auditors are typically green having quotes. They're fresh out of college. Maybe they got their C P a license. Now they need experience to become a full fledged C P. A. You need a believe it's two years. I think the qualifications have changed, but you need to put your time and do the grunt work and, unfortunately, grunt work is going on site with clients and doing their audits. I'm working through the information. It's not fun, 60 to 80 hours a week at least. Um, besides the time they're spending in your office all day for the audit, they're going back to the office of work in the evening and putting information together. Um, when they do work at your office, it's typically not optimal conditions. You know, they're stuck in a conference room. They're stuck on a foldout chair there, shoved in office that have that's used for storage. Whatever the case might be, there is kind of pushed wherever they can, because typically you don't have available space for them to just have their own office. Um, and then as well, they have to ask hard questions and be a nuisance. They don't necessarily like doing this because they know they're inconveniencing you. You're trying to do your job. May be in the middle of something, and they're coming to you with a bunch of questions and asking you things and asking you to produce schedules, produce copies of invoices. So it's not fun. It's not a fun job whatsoever, but unfortunately it's just part of the audit and part of the audit is you providing backup in information explaining things to them. They typically have toe work under a deadline, so the autumn might be scheduled for two weeks. And if you're dragging your feet not giving them information, it's their job to bug you and make sure that you get from the information that they need to wrap up the audit, um, their audit work. So the auditors, the junior honors, are reviewed by peers and partners. So everything that they do, they want to make sure they do a good job because they want to keep their jobs. They want to be impressive, so they're gonna work extra hard to make sure that they get all the information they need. Um, and it might seem like they're trying to find things that you didn't correct ultimately just trying to follow procedures documenting things that they need to document to meet their own guidelines on that as well. So they can say, Here's what we proposed you do to fix this. You didn't incorrectly no big deal, but we need to fix it, and here's what you need to do. So there's not necessarily a lot of judgment coming. It's just more. They're trying to get as much information as possible so they can make sure it could be fixed correctly. Andi, I think that's the perspective you need to think of it from rather than they're trying to say, Well, you did this wrong, Shame on you. It's not so much that they're just trying to fix everything so they can and say We reviewed the financials. We fixed any problems, were happy with them. Now with that, that's kind of it. From the auditors perspective again, I encourage you to go easy. Um, the old saying attract more flies with honey, Whatever it is, be nice to your orders. You will facilitate a much easier on it if you're nice with them and work with them than try to work against them and push them away and create a headache for them because they do . They're ultimately gonna have to get through all this information. Um, so I encourage you to just try and work with them. And if you don't understand something or you don't, you can't give it to them. You can't find an invoice. Just tell them that and say, Look, I don't know what we can do here. Maybe you can select something else, Whatever the case might be, work with your auditors, Um, and you'll make your life a lot easier. And I say this from someone who I've worked with auditors for years and years now. And I think it's something I always end up doing, especially as your company growth. It's only gonna get more complex, so build those relationships rather than make it difficult. 25. Audited Financials Audit Process: So lastly in the section, now that we know a bit more about the auditors and how to find an honor, we're going to talk about the audit process and the things that you're gonna have to go through. Um, as you work with your auditors eso first of all, auditors to a quarterly review and then annual audit. I think we established that reviews. They're not as in depth of the audit, so the Corley reviews probably might not even be done on site. Depends on the size of your company. Might just do it through email that request stuff the last things like a General Ledger trial balance. They'll pick selections and ask you for backup of transactions like copies of invoices, for example. Um, typically, review takes a week, and audit takes two plus weeks, I would say two weeks on site and maybe additional time off site. Once they complete the on it, they'll issue an opinion letter, and one of the samples provided in this section is ah, sample of an audit letter, and there's a fairly standard format they have to follow. They have to say specific things and that that will be in this sample letter. So now the audit process s o a. P B C list prepared by client list is issued in advance of the audit, so they give you a list and I'll mention right now there's a the other sample included with the section is a copy of a PBC list a little bit older, but it gives you a sample of what types of things they asked where they ask for things like the financial statements. The general ledgers trial balances schedule supporting the different movement on the balance sheet fluctuation analysis on the income statement. Copies of any board of directors minutes. Copies of employment agreements. Substantial ones like executives, um, other contracts that the company may have entered into some of those things they call it permanent file. They just want a copy, and we'll keep it. Other things. They just are month, a month or year to year things like changes in the financial statements they need. So they give you this list. The PBC lists in advance of the audit on the client puts together all this material, the schedules, the backup, the financials. Typically, these states, you see it done in soft copy digital copies that you can have it and send over my tip is always to do it. The PBC list is usually numbered. Some number the copies correspondingly. So if item number one is the financial statements, label your financial statements, one period financial statements. That way they can quickly reference stuff. If you just throw a bunch of files at them with different names. And some things are weird names, they're going to spend half their time just trying to match things up and figure what they have. And you're trying to make their jobs a little bit easier. So on the next slide, I mentioned a few PBC. I'm Lisa's contracts. Board directors, new employees, financial statements, roll forward schedules. That's pretty much the bulk of what a P. B. C list is. And again, you're getting this list in advance of the audit. You'll prepare all this stuff and give it to them, and then they come and then they do the review and ask more questions. So honors typically spend two weeks on site. So we're talking about a year and got it. Depending on the size of the company, that might just have one auditor out there, they might have four. Um, if they have for each of them would be assigned an area like one is in charge of assets. One is in charge of revenue and all things revenue related in large, publicly traded companies, we would have about four otters and then 1/5 person. It was kind of the lead manager, if you will, who kind of facilitated the whole process. So typically the way they work is they set a threshold on what they need to review. So again, a large company with so much transactions, they might say, OK, we're only interested in expense items, which make up 10% or more of your total expenses, or 10% of revenue whatever metric they use, so they don't care about postage. They don't care about the fact the postage went from $20 to $25 this year. Not interested. Nodding that they are interesting. The fact that salaries went from one million to 1.5 million. Things like that, they want to vouch is the term transactions. They just want to see backup for transactions and they'll tell you what transactions those are. He provide them with the General Ledger list. Every transaction you've done in the period, they'll then highlight and make selections and say, I want to see a copy of this and vice this invoice. I want to see this employment contract for this person's payroll. Things like that. You paid bonuses. I want to see that. Where? Somewhere where you have a document, What their bonus percentage would be. So they want to verify is what they're doing. And now a little bit more about on site on it. So, uh, owners will create work papers to document what they reviewed, how it was tied out. Um, they could then have these internally for their own use as well as their managers will review it and its documentation for the PC, A or B. If the auditors actually got audited, which does happen, I think it's every year. Every two years they have to have an on site visit, make sure they're properly conducting their audits. They create a permanent file for documents so things they only need ones, contracts, board of director, meeting minutes, things like that. And then what you can do is if they ask a question. The subsequent year and say, Hey, we need a copy of this. Where can we see someone's those bonus agreement? You know, they already have a copy of the permanent file, and you can reference that they won't always remember. They seldom do just that. They have so much information, different clients they're dealing with. But if you can remember, you could let them know then. Often they have to be walked through specific transactions, so abnormal or unique things to your industry. So, for example, I have a client who has deferred revenue. Deferred revenue means you've received a bunch of money as payment, but you haven't performed the service yet, so think about membership. Um, they're thinking about Jimmy when you pay up front for your 12 month membership. But really, they earned that money every month. It's not like they earned it into your one earned month one. Even though you paid it, maybe you don't have a right to get your money back. They technically earning that money over the 12 month period, so it needs to be spread out over 12 months. Um, a non it firm are new. Auditor would probably wanna be walked through my schedule. How did I come up with this? What's the criteria for deferred revenue? That amusing? How do I spread it over 12 months? How do I make sure it's properly reflected on the financial statements where the entries are making things like that They want to be walked through so that they feel comfortable that's being done correctly and then, lastly, post on site. So once they do their audit and now it's past the fact. So first thing they do is they wrap up the audit at their own office. It's not like the audit finishes the day they leave. They still go through the work papers. Maybe they forgot to get something. They'll ask you for that follow up. Um, we'll follow up with questions if there's something that didn't quite understand. And now they're kind of circling back to the last for that. Ultimately, what happens? This? They issue audit adjustments. So they say, Okay, based on the audit, we found these few things that we think you need to correct. You don't have to agree with, Um, certainly you can argue with us, but you need to be able to have a stance and you need to come to some agreement with your auditors because they're not gonna issue their letter until you're both on the same page. Usually their audit adjustments airfare there is trying to fix things that they found that were maybe incorrect so the company can accept them as is, or discuss them with the auditor. And then, once you agree on them, you adjust your financials. You set out of final kind of version of the financials. They'll look through them, make sure they reflect those adjustments and say, OK, yes, for good. And then they issue the opinion letter, which I gave you a sample of a swell in this section, and that's pretty much it for the audit. It's definitely a lot of work. It takes up a lot of your resource is as a company encourage you to work with your auditors , not against them. But at the end of the day, you haven't audited set of financial statements. You have a letter that you could give to potential investors where you can use if you were to go public and say, Yes, we've had our financials audited for the prior two years already. It's a constant a burden that you're not gonna have to deal with now, after the fact is, you tried as you have 20 million other things to do. So um, and occurred you. If it makes sense to sort of get involved in the audit process, find auditors who worked well with you. A lot of stuff can t be done remotely. It's not to say that all sites are a lot. It's our on site of, um, two of my clients do their audits remotely, completely, even the year end. We just work through a mounts than stuff back and forth. Um, and that's about it. So hopefully odd to turn a scary As you're thinking there, There are a lot of work. I'm not gonna lie, but, um, it's not as scary as you think it is. It's more of the amount of work that needs to be done. 26. Addtl Financial Reporting Waterfall Report: in this section, we're gonna talk about a few additional reports that you can generate, especially in a smaller companies. Small business, a start up company that I think are really useful in the 1st 1 is gonna be the waterfall report. So included in the section is not only a download of a sample waterfall report, but I did a stream cast video that I recorded already walking you through the waterfall reports. So today, in this lecture, we're gonna talk about the water or fall, report what it does a little bit about it. But I think when you actually see the waterfall report, that's when it will really sink in for you what it is and how it can help your business. But first, to give you some background information on it. So Waterfall report is a cascading style report. Hence the name. It's a report which compares actual results against the budget. And I'm gonna draw just a quick sample up here in a minute after we get through the lecture , Um, so first, the budget for future months is displayed and then, as well, all the revisions to it each month as you go along Based on the actual results, you might revise your budget. So the purpose of this waterfall report is to show you what the original budget waas and how the actual results ended up being. And then how you revised your budget going forward and each month, what the effects are. Are you contain Lee updating your budget, or is your budget still on track? Etcetera? This waterfall report could be done for any metric. Basically, you can do it for your cash balance, your revenues, your net income, your salaries, expense, whatever it is you want to track. Um, that is fine. As long as it's a number that you can pull from a financial statement, you can use it in a waterfall report. So next you typically only see this report and fast growing companies. I think it could be applied in any company. Honestly, I just think that it's more of a recent report, if you will. Wouldn't have been around 10 20 years ago. Um, so you don't see older companies adopting it. But I have seen in a startup environments, and I think it's a super useful report. It gives you that insight as to not only how your forecast performed. But then how You're making changes and you can learn as you make changes to the forecast. Um, you know, what was the reasoning behind that cause? A lot of times, that reasoning of loss, you just revise your forecast and you kind of forget about the old ones. Where is the waterfall? Report forces you to look at the old ones and say, Oh, look, we've really scaled down our revenue projections. Well, why is that? It makes you think about those things. So it's useful for not only tracking the changes, but as well. It's just trends. So if forecasts again is continually being brought down, down, down, maybe there's a problem with your forecasting, especially because not only did you not have the right number to begin with, it seems like each month you're continually having to bring it down. By the third or fourth month of doing that, you need to think through Well, what is it that I'm missing? Something's not happening that I think is gonna happen. So that's it for the slides. There's not many in this lecture, so I'm going to draw you out for waterfall report really quickly, so typically have your original budget. So this is your starting budget and you haven't for January, February March and going forward. So let's say this with $10.10 dollars, $15. Let's just say its revenue Then here you have January, February and March, and again you'll see in the actual sample in the video cast the screen capture, um, what it looks like a bit more formally and obviously, but more clean there in this. So for January. Let me just draw these in, and then we'll see. We kind of ran out of space, so the boxes represent actual results. So here's your forecast going across. Here's your actual month. So in the month of January, we have our actual sales ended up only being eight. It's a little bit less than the forecast, so based on that, you would re enter your forecast. Maybe it's the same. You don't change anything. Or maybe you going You know what? We're really not gonna meet 10 and 15. Instead, let's change. This also ate in this to 10. So now February rolls around and you have sales. Let's say let's just use the common example where things just continue to go down. Hopefully, that's not the case with the actual results. Come in. It's six. So now you're gonna do two things. One, you're gonna re forecast March and going forward. And the other thing you're going to do is you're going to start looking at this and going Well, we thought it was gonna be 10. Then. We thought it was gonna be eight and then ended up being six. So what's happening? One of my missing that I'm not doing right here. So maybe you figure that out or you think about it. You go. Okay, well, let's make this eight. We still think we can do OK here. March comes along and it's only se seven. Continue this downwards and you can see so we have the original forecast. Still, you have your revised for a cast of 8 10 Then it became 6/8 and it became seven. So we originally went from a forecast back at the beginning of the year, 15 for March. Now all of a sudden it's your actual results for seven. So something is happening. That's what this report does. So rather than just create new forecast and kind of forget about this past history. You have it all displayed outwards, so I think it's a tremendous report, and then you'll see in the sample, Um, you get your quarterly totals and your your yearly total, so you can really see then what your revisions air doing to your to your projected numbers . And again, we said, Is the sample be revenue? Really? Could be anything could be a cash balance or any metric that you contract. So in a in a nutshell, that's Ah waterfall report again. It's that cascading nature that gives it its name, hopefully finding use fighting is tremendous, and I really don't see it often enough. 27. Addtl Financial Reporting Budget vs Actual: So in the second part of the lecture for additional financial reports, we'll talk about budget versus actual. So this is an important one. And you see this and more companies where you essentially, you take your actual results each month and compare it to your budget numbers. So, like the waterfall as well. I included a sample of a budget versus Actual, and I included a screen cast where I kind of walk you through it. So we're gonna go through a few slides here. I'm gonna dry. What a simple one and then encourage you to watch the screen cast and look at sample to really get a new idea of one in action. So, first off, comparing your actual results to the budget is where you gain knowledge from volume reporting. You know, you create all these reports. It's one thing to create the mall, but it's really the information that you take from them. That's the most important. So I understand why the budget was one way and the results were another. So we kind of mentioned in the waterfall report. You're doing that as well. You're kind of looking at some metric and saying, Well, Why is it going down or why is it going up? You do that on a bigger scale with the budget versus actual on. The main purpose is to learn from your mistakes and correct them going forward. Did you? Just over budget and completely any need to re budget. Maybe there was a big sale you were anticipating. It just didn't happen. But it is gonna happen next month. Things like that. You can count on, um And as you work through the logistics of why there was different variances, figure those things out and decide again. If you need to re budget or not, Ultimate At the end of the day, you might have a few purposes. One is to forecast your cash at the end of the day. You want to know? When are you gonna run out of money? Especially if you're in a start up environment? When you gonna run out of money, When do you need to re raise more money? Um, or you just want to know when you're gonna turn a profit. A lot times during that loss mode for the first several years. When do you turn a profit and kind of accurately budgeting and forecasting is what's important. Teoh. Figure out what it's gonna take to get you there. Um, the next side. So as well. As if results are better than budget. Don't just go. Okay, Great. They were better and move on and forget about it. Figure out why it is that you won't perform. What happened? Maybe you've got a sale early that you weren't expecting to get till a few months down the road. But that might mean that a few months down the road, your budget first is actually gonna flip flop and won't be so great because you're missing that sale that you already took. Just understand those things and know what impact that has on your financials. Not just now, but in the future. Um, and then as well, if your budget wasn't met wasn't a one time issue. Is it gonna be repeating? So again? One time issue might be a sale was delayed, but it's coming next month. If it's ongoing. Maybe you hired more staff than you anticipated in the budget. That's gonna be an ongoing thing. You might want to think about revising your budget. So let's just draw out a very sample are very simple. Budget versus actual will. Just show your company name. Um, actual results, budget and a variance. And typically you only look at this at the P and L, um, level. You could certainly look at a balance sheet or cash flow, but we'll focus on a profit and loss statement because that's really where the action is. So you have your revenues, your dogs on your op acts, and he would have them each listed out on your net income. So you have your actual results. 10 5 whatever. 1111 and then your budget waas 15 7 0.5 point 751.52 and then you have your variants. So you're variants. Depends on the line item. A positive variance means a good thing. So, for example, are actual results were 10 for revenue or budget was 15. That's a negative. Variants are cost of goods sold a was a, uh, we actual result of five. We'd budgeted seven, so that's a positive variance. Think of it like that. Any work your way down the row on, and that's pretty much it. You then go through you do your variances. I'd encourage you as well to add a percentage column just so you can see how big the the delta is between the two will help you key in on. Especially if this ended up Being 20 items quickly draws your attention to which items are the problem areas. Um and it worked through this thing. And then again, the point is to look at these numbers and figure out what went wrong. Like, I'd really be curious about the revenue. Why was it only 10 when we budgeted 15? Is it a one time thing or isn't it ongoing problem? Eso What? That actual versus budget? In a nutshell. Again. Look at the screen cast. Look at the sample. I think there, uh, completely useful and tremendous. And I hope that you understand them. Email me with any questions. 28. Addtl Financial Reporting Budget to Actual Review: in this video. I want to walk you through the actual the plan or budget versus actual whatever you want to call it, um, of the sample provided So you actually have the sample provided as part of the course material, but I wanted to walk you through what it looks like. This is an actual one. We've changed the names of the company just so it's not, doesn't give everything away. It's obviously a few years old, but it doesn't matter. It's all the same kind of principles. Apply. So what this is is it's for an individual months of December 2006. Um, this company had, um, product ABC. So they had three products, and they as well calculate the transactions and you'll see there was no revenue for products. See, which is why there's only Procter and be a transaction. So they did account. Or, if you will, this will be like the number sold would be one way to think of it. Um, one thing I'll mention is there's a few numbers highlighted in blue here They did. If I fairly dynamic budget their actual where they actually, then you could click those numbers as it says here, and it would give you further information so it would actually jump to a section in the workbook that would further explain the numbers themselves. We won't get into that, but for now, just know that that's what it is. So we talked a lot about, um, you know, kind of variance analysis and learning from from comparing the actual versus budget. So very simply in the first column here we have the actual results for each of the categories. Come in the second column. We have the plants that these were the original budget numbers and then we have the variants. So, for example, there was for product a ah plan of selling 24 widgets, if you will. They sold 38 so there was a positive variance. Likewise, for a product be there was a plan to sell 12. They only sold night, so there was a negative impact here. And you see that reflected in the revenues as well. They were well ahead product a revenue but a little behind a product. Be looking now at operating costs kind of all your standard operating cost payroll bonus, payroll taxes, benefits, travel, marketing, accounting etcetera. So for each of these numbers, they can put the actual results that compared it to the plan on. One thing you'll notice is the plan is very. It's not nice round numbers. So these numbers were derived from fairly specific calculations. It wasn't like they just budgeted 40,000 for payroll taxes and 30,000 and 3 10 these numbers were actually really driven a well thought out. As you go line by line, you can look at the variants, and one thing that's doesn't have is kind of a percentage, which might have been useful because you could quickly skim look for the items which were a high percentage item. For example, um, contractors. They use 43,000 whereas the plan on Lee called for about 17,000. So there was a fairly high variance. Um, and that's why. And I noticed thing here that the blue numbers air some of the bigger ones. That's why there have a link to them so you can click on them and and learn the explanation as to why they're off, even though there's a few here that aren't, um, and things that might make your ears perk up. Our, um, payroll is fairly dead on, but payroll taxes were fairly off. They were actually a lot less than actual or than plan. So what happened there? So they were good to the plan? Um, positive variants. But why? Why is that? So, um and hopefully there's an explanation. Maybe they got a credit or some other thing so you would continue down. So this is basically it's just scared them back up your profit and loss. You have your revenue, your operating costs. And this was a service business. So they didn't really They had cost of services, but it wasn't worthwhile to calculate Hm there. Captured in here essentially. And then they have their net loss, and obviously this. So this was the start up companies. So they were losing money. So that's why there was a loss. Um, but positively, they didn't lose as much as they thought. They thought they were gonna lose 3 97 They only last 3 70 approximately. So this was compared to plan their next section. These people actually did. And actually, I built this report when I was CFO of this company. Um, they compared to the prior month. So beyond just comparing doing budget to actual just kind of go through this with you even though it's, um, not quite what we were discussing. But I think it's important to see so you can see the growth. You see. Revenues grew only slightly for product be, but for product A. They did payroll brute grew a little bit. Bonuses were the same. You can go down the list and actually highlight the big variances that contractors grew quite a bit. Um, recruiting costs fell dramatically, so they probably hired some people here that they didn't hire. In the next month, he would go down. Maybe the 8000 office telephone seemed to jump up. They might have expanded offices. I don't quite remember marketing decreased, so she would go through this and kind of highlight the things and then dig in. So you take this a step further and go investigate why these numbers change. That's a dead, um so is the whole Their operating costs fell dramatically, but a big chunk of that was due to the recruiting costs. And then you have your income, your net income, you have a few kind of ah misc items here that Aaron is important and they're fairly dead on. And then you have your net loss. So they lost less in December than in November. So that's a positive thing. And it's positive by about 96 K But of which 82 k was in the recruiting section, so important to know. And that's kind of how you would go through a report like this and do a quick summary of it , and then you would dive deeper into each of these things. And then the same for the, um, the actual divers is plan and figure out, you know, on the big variants items. You know what happened with contractors. Why do we Why were we so far off here? Why were so far off on office and telephone, Um, and then to the positive why we're payroll taxes favorable by that amount. I mean, you don't just want assume that the good things you should skip over. You should still dig in and try to figure out um, what it is that caused that positive. Arians 29. Budgets and Forecasts Budgeting General Concepts: in this next section, we're gonna talk about, um, budgeting and all the things that go into creating a budget. So this first lecture, we're gonna talk about such some general concepts in budgeting and forecasting. Then we're going to get into the specifics of each of the the sections of the budget, if you will, the assumptions and the different financial statements, how to properly budget them. And then lastly, um, I provide you a sample budget with all the multiple tabs broken out in pdf's. And then as well, there's a video screen cast of me walking you through those different tabs, so you get a sense, so we'll talk a lot about it here. But I think when you see it as well, it will really sink in. So I encourage you to watch these first few lectures go through the video screen cast looked at the sample. Then maybe if it's still confusing, come back and re watch on these first few lectures and maybe the information that will make more sense once you see it, Um, Or maybe it'll all thinking so. First of all, just some general information. So term budget forecasts we're going to use interchangeably. Typically, um, technically speaking a forecast, you would forecast your revenue. You budget your expenses. I just Typically, it's all done in one Excel spreadsheets. So I just use the terms interchangeably, and it just means forecasting or budgeting forward several years, several periods, revenues and expenses. Regardless, um, projected financial results usually do for a year to five years. So, depending on the purpose, if you're kind of in a larger corporation, usually do your budget for each year on an annual basis. If you're in a start up small business environment, you're typically projecting ahead 3 to 5 years because you're trying to see when you break even how much money you need. Um, and you want to show investors the potential, and usually it takes that many years for your business model to really ramp up. So that's why you do it. 3 to 5 years In the real world, people know that a five year budget doesn't mean much. Um, it's hard. Nobody can predict that fire in the head. But you try to do the best that you can, and you work in logistics and assumptions. That makes sense. And then hopefully you can get there, says here. Five year forecast is the best guess. It's hard enough to forecast I had one year and you'll see that once you do more and more of these and get involved, it really is. It's difficult toe kind of hit the mark just cause so many things change. Business conditions change company changes. They launch a new product they weren't planning. Originally, all sorts of things can happen. So next level details determined by you and the company. So what makes the most sense? I've seen budgets done on a very high level revenue cost goods sold the few expense items, and that's it, maybe for one or three years. Then there's other people who break it out month by month. It's driven by every single possible revenue and cost driver possible. Um, it's just becomes a monster. It becomes difficult to deal with. I tried to shoot for somewhere in the middle. I like the level of detail of having month by month, if not quarter by quarter. I like having enough assumptions that you can really drive the model and you can tweak it and find tune things without not just a blanket assumption, but the same time trying to condense it in some level. Um, there's some details that are so minute. It doesn't matter. You don't need Teoh. Forecast your electricity down to the kilowatt. That doesn't matter. You can put in $100 for power. Whatever the case might be something like that. The level details not need it that on the level of detail that small, um, also, you should, um it uses a benchmark use your budget as a benchmark each month. So we talked about comparing your budget to actual. Now we're talking about creating this budget. Take the budget, actually do that budget to actual comparison. I think it's an important exercise because then you can see one. How good a job you did a budgeting to where things went right and where they went wrong and then next. Um and then that's what I mentioned here. Buzzer first is actual seeing what went right What on what? Didn't, um you'll never hit it 100%. So some will be good. Some will be bad. Look at the big variances and figure out what it was that you need to find tune going forward. So what else? What lessons are learned based on that comparison. So, um, maybe you learned that you're a terrific budget and forecaster. Or maybe you learn that you really overthought the capacity of your plant. Um, you just can't quite get there. You have to bring in extra labour. You're gonna have toe added an additional rental space. You need to work more hours in the day. Whatever the case might be, you're gonna learn some lessons. So take the numbers, compare them to the budget, and then figure out what that means in the real world. For your business. Um, how often do you want to revise your budget? Monthly quarterly? Never. There's different kind of mindsets around that. I'm a big fan of constantly kind of revising it, not making it a full time job. But you want to find tune it so that going forward, you're working off a budget that makes sense. There's no point sticking it out with the original budget. If it's just so far off the mark, it doesn't make any sense. When you get into like, bigger companies and you're kind of stable and fairly predictable, then it makes sense create a budget for the year and try to stick to it, and that's your goal. But in a growing start up environment, small business, I was say, you should have no problem revising your budget. And then that's where that waterfall report we discuss comes in because you can see all the changes that you're making. So it all kind of kind of comes together at that point. Um, the terminology uses a static budget would be where you just create a budget and don't change it. A rolling budget is where you continually updating it, and then also, you can use a budget to benchmark my department. So, um, in the examples we look at, it's just kind of a company wide budget. If you were large enough that you did a budget by department, then you can use that budget and apply it each month and look at different departments. How did marketing do? How did accounting do? How did the sales department dio and really compare it month by month by each department on that level of detail? Ah, final point bonuses are often tied to meeting the budget, so that's why you might even do it on a department by department basis. Um, you give your kind of key executives goals, and if they meet certain budgets, they get a bonus and their budget is tied or their bonuses tied to it and maybe appreciates your declines based on how far off their budget that it is. But at the same time, you need to give them the tools to to do what they need to do. So you need to let them know what their budget is. That for their department, um, and then just a little bit about presentation. Traditionally, the budget is the, uh, the primary final financial statements. The three statements is your end goal In the sample we look at, there's gonna be a bunch of other tabs, and they're all basically building up to the statement of cash flow, uh, profit and loss and balance sheet. So your budgets also an internal document. This isn't something you're publicizing. You don't put it on the SEC website when your public, none of that, um so it could be whatever you want it to be, and it can take whatever format makes sense. I think there's a lot of standards out there, and I know when I build them for companies and clients, Um, I try to follow a standard format, and I've seen a lot of budgets from other people. So I've learned the good and the bad from other people. And what what makes sense of what doesn't? So I tried it pass on to you kind of the best business practices in terms of budgeting as well. So I recommend you always have a set of assumptions is kind of your first go to place, and you'll see in the example, if you get your assumptions right, you're halfway there cause and it will take half your time to do that. The rest just becomes an exercise and linking and properly mapping different accounts and building your financial statements. If you have all your assumptions built out correctly and have informed numbers in there, your financials will fall out and then you confined. Tune your assumptions based on the results. I usually including next summary that just ties all the financials together. Just cause it is, it's fairly complex, and you'll see the in the sample sometimes some graphs and then I have the detailed financials month by month as well. Possible additions that you might throw in with your budget or your forecast. Um, and I didn't have these on the example. You don't see them is often Maybe evaluation. So use that information to come up with evaluation, and we're gonna talk about valuation in the next section. I believe, um, who talk more about raising capital investors. You can create a preliminary evaluation using the information in your forecast. Some other people will include return on investment as well. What kind of do some calculations and so wealthy? Invest one million. Here's how the money gets used. And here's what your return would be. Eso with that. That's an introduction to budgeting and forecasting that we're going to get into each of the sections on learn a little bit more. 30. Budgets and Forecasts Assumptions: so the first thing I mentioned is the assumptions tab. And really building a good set of assumptions is what's fundamental behind any forecasting and budgeting exercise. So first, let's just go through a few terminology things. A revenue driver or a cost driver. It's some factor which, when it increases it directly impacts your revenue or your costs. So the number of widgets to sell is a revenue drivers. Well, it's the cost of goods sold. Driver Number of Web site visitors say you had just have an online portal and you are advertising money, and you've kind of figured out the ratio for every visitor you get. You earn a dollar in advertising revenue. Um, so that would be your revenue driver. Ah, rolled up budgets that sometimes you hear about a rolled up budget just basically means taking all that extensive information and condensing it. So taking your profit and loss, all those operating expense line items, rent salaries, rolling it up into one line that's just says G and a expense that would be a rolled up budget. So it's a more general information. So the more detail, the better. Again I talked about you don't need to budget your number of kilowatts. You're gonna burn in your factory, your office. But in general, I think it's good to list out at least every line item that you would typically see on your financials budget kind of the same way you present your financials. Um, also encourage you to budget by the month and not by the quarter, and definitely not by the year. There's a lot of detail that can happen in those months that you want to properly include, especially if you're in a growing company. Your one of your goals is probably figure out when you run out of cash or we need become dangerously low. And it could only do that if you're looking at a month by month basis. So whenever possible, tie together revenue and cost drivers with expenses so you can save yourself some hassle. A long run if you map. Like I said, revenue and cost drivers. So maybe the more widgets you sellin month. You know, the month of March that your marketing expenses driven by that for the prior month. So the idea is that you market a bunch, put money into marketing, and it drives your sales, so you have some type of link there. The more you can do that, it'll make creating the financial parts a little bit easier and put a little bit more rhyme and reason behind your budget. So as well, all your assumptions should just be a one tab, a big fan of organizing your budget in a good manner. I've seen forecast where they might have assumptions littered throughout the model. Different tabs on each financial statement that kinda have assumptions. I'm not so much a fan of that. It's too easy to lose sight of where you need to enter information. Um, and when you need to change something, it gets lost. And definitely another thing I don't think I have on here, Um, I might on the next tab how I do. But, um, I'll mention it now is don't embed formulas don't bed rates things like that. So, for example, a tax rate if state taxes, you estimate, are gonna be 35% of net income, don't embed the 35% in the formula in your P nL because the tax rate might change or saying months where you have a loss and you're not paying taxes, you don't need that 35% built in. So making an assumption where you enter it once. 35 tax rate box 35% and away you go. You then linked to that in your income statement, and you can change it on the Assumptions Tavern. It will update all the financials, and that goes true for any assumption. You want to put it on that assumptions tab and not have a built in somewhere where you're going to find it. Later on, it's on the next side. So when creating a budget from scratch, look at other companies for ideas. We'll go through the sample. Um, there's a 1,000,000 different ways to create a budget. I'd encourage you to at least look at a few to get a sense of what different ones look like . So people often omit items they shouldn't. Payroll taxes, income taxes, amortisation. These are all real expenses. People just think about the things like revenue costs, salaries, marketing. Okay, I'm done. No, think about all those other expense items that you need to include any assumption or variable, which should be in the assumptions. Leave it in there so again, that was the income tax rate. Leaving on the assumptions tab. Don't build it in somewhere else. Payroll tax rate, etcetera. In an ideal world and the way I build them, there should be no input other than the assumptions tab. If you have ah inclination to add some input section on your income statement, put it on the assumptions tab. Then somebody can go there that can fiddle with it all day long and then go look at the results. So an example here of just proper kind of best business practices. So payroll tax rate is 10% Option A. Create a formula, which the salary times 10%. So that would be on your income statement. And that's a no no option. Be creating assumption, Self for payroll tax rate and the formulas now salary times. The payroll tax rate payroll tax rate would be on your assumptions tab. Um, and you can, even if dependent, how handy you are. In Excel, you can name cell so rather than linking to sell B 52 on the assumptions tab, you could name that sell payroll tax rate. There has to be no spaces, but just payroll tax rate. So then your formula on your income statement would literally be salary. Or maybe it's linked to a line like, you know, Selby four times payroll tax rate. That makes sense. When you look at a formula, you okay? I see what the cell is doing. I'm so using option B. No, you can easily change the input cell if the ray changed, etcetera. So imagine an income statement that has 12 months and then for three years, they have 36 cells. You can either have it once on the assumptions tab or built in 36 times on the P and l. I think you at this point, you understand what I'm in favor of. So lastly, you know all other tabs. The financial should be linked to the assumptions. Um, no, we use their input. Should be done on the financials directly again. You just you lose things you forget update thumb assumptions that are the most important part of any budget. Spend the most time making them clearly in the mount properly, in a format that makes sense thinking through. So not only building about thinking through the numbers you're putting in your assumptions and then the remainder of your budget should be piece of cake. It's really an Excel exercise of building your financials off of those assumptions. So what? That that's assumptions. Now we'll get into each of the kind of the financial statements and the do's and dont's for those. 31. Budgets and Forecasts Income Statement Forecasting: So next we're gonna talk about the income statement and and forecasting it. So just to recap, I mean, we've built a lot of stuff into our assumptions. Tab s o. Some of this I'm referring to the profit and loss, but really might want to think about the assumption section that relates to the profit and loss because that's where you're doing your actual input. So, first of all, the income statement profit loss should be fairly detailed, line by line for revenue. Whether that's by product, by geographic location, even if it's just services and products, some level of detail, a swell cost of goods sold and your expenses should all be broken out. Um, month by month has always favored over quarterly or annually definitely not annually. I mean, save the annual for your summary tab, but in the actual forecast, do the month by month so you can look and you can actually read these forecasts. And then you can use that month by month forecast against your actual results. Um, include totals reach years, you'll see in the sample. We have kind of the 12 months and then a total 12 months total. That way you can quickly reference what the annual total would be and a typical forecast of 3 to 5 years. Again, I would say, just if given the choice, I would just go out three years. So, first of all your revenue. So your revenue drivers from your assumptions is key aspect. When it comes to revenue, revenue should always be a multiple of, ah revenue driver times the revenue per item or per the revenue drivers. So again, your revenue drivers number widgets yourself. Times the price per widget creates a revenue. So don't conversely, that just throw in a number of $1000 in revenue in January. Well, where's that $1000 come from? If you have the revenue driver in the price per widget broken out, that makes a bit more sense. Think also, a good way to think of all of this is 1/3 party looking at it. Are they going to understand it? If you just dump in numbers grand totals $1000 for every 2000 where those numbers come from , they're gonna ask a lot of questions. You're better off and you're gonna forget to where you originally came up with your forecast it's better to build it in, um, and do the math, So be specific. If you have multiple items and revenue, break them out if you know if and what makes sense. So if you have three products, break them out. By all means. If you have 100 different products, maybe you group them by product type. Do what makes the most sense and then is while you want a building growth. So again, that's the purpose of that. Month by month is. Hopefully you're anticipating some growth in your revenue, and you can see that grow over time. Um, and you do that through your assumptions tab. You you more right? I'm sold. Probably the pricing stays the same, but build that in so you costs a good sold slash Cost of services should be directly related to the number of units sold as well, so again driven by the number of units. That way, there's a direct tie between your revenue in your cost of goods sold if there's any scaling battery built into your assumptions as well, and will flow through your financial reports. So by scaling, I mean, you know, if you buy 10 units so assume retail environment You by 10 units, you pay $10 per unit. But if you buy 100 units, they give you discount only paid $9 per unit. Build that logic in and again, it's just formula. So it just takes a bit of an excel. Know how. And if you don't have the know how, find someone who does and they can build it for you. Um, use the best guess if you're not sure on Cog. So again, going way back to our manufacturing examples, You don't know at this point when you're forecasting what you're fully burden, cost is gonna be You might have a best guess. Use that for now. The point at this point is just to build the forecast and get it in place and get a good idea. Um, no forecast is 100% but he could at least try to get as close as you can, and then your lines should match the revenue line. So if you broke out your revenues by product group, break out your cost of goods by product group. Don't just break I revenue, but have one life for cost of goods and certainly don't break out by product group here, but then by individual item and Kosta gets sold. Try to match moving on your expenses so you're selling expenses. So marketing, if possible, should often be tied your sales as well. So marketing this month's relates to the sales that you generate next month or whatever makes sense in your business. Some selling expenses might be consistent, though, so you have a VP of marketing is always gonna be $10,000 a month. So that was not so much tied to the amount that sold. So factor in all aspects of anticipated marketing. So just marketing methods, salaries, promotions, giveaways, bonuses, whatever it is. Television campaigns, whatever it is you do, build those in. And if you can do a detailed level, and what you might dio depends on how you want to structure it. I've seen some companies break out entire marketing assumptions Tab on it don't just because it's such a huge section. So rather than clutter, the main assumptions break out of marketing assumptions. Um, I'm OK with hat. I'm not trying to keep everything on one assumptions tab, but if it does get too unruly, maybe then you want to start breaking out what makes sense like a marketing assumptions tab for G and A expenses all other expenses. So I left off. In our previous examples, we talked about our India's well, I left it out here because it's not as common in a lot of companies. But certainly all these rules kind of applied. Whether you're breaking out R and D, you're breaking out travel used the same methodology. Um, so Fergie and a typically again do it on the line by line item basis related. Relate the expenses to other expenses when our other drivers whenever you can. So, for example, your salaries should be driven off