[MUSIC] The parable of the fisherman. Let's draw the balance sheet of our fisherman's company when he creates his enterprise. The fisherman uses the fish money to finance his fishing company's equity. With the shareholders' equity, the company buys his boat. Create your company can separate your family assets from that of your business. His company may borrow to buy more ships. Create a company allows to pool funding. The two ships generate income from fishing, but also expenses. The income statement measures all income generated by the business during the period. Minus all expenses incurred during the period to generate this income. The difference between income and expenses is a profit when positive, or loss when negative. If the company makes losses that eat its equity, it will sell its boat and repay its debts. If there is not enough, defaulted creditors will not be able to go after the fisherman. Create a company can segregate the risk of your venture. If the company makes profits and the fisherman needs them in the company, retained earnings will increase equity. Our fisherman may be able to end his partners interested in the profitability of the business. In addition to retained earnings and your capital, the fishing company may obtain new loans, buy other boats, and employ other fishermen. Create a company is a way to work in collaboration with partners. The balance sheet is a snapshot of the company at the end of the year. The succession of snapshots makes it a film. >> In reality, a balance sheet is a little more complex than this little film. Because it presents a company's financial position at the end of a specified date. And your venture may be a bit more complex than the simple fishing company. Some describe the balance sheet as a snapshot of the company's financial position at a point in time. How does it look like? Horizontal format is common in continental Europe. With assets on the left and liability on the right. While in the United Kingdom, the more common format is a vertical one with assets on top of liabilities. Various European directives require to classify assets starting with non current account on top and current accounts at the end. It is American practice, north and south, to do the opposite. Consider the following European example of a balance sheet. Reading it may seem confusing at first, but I will give you two tips. One, on the difference between the left and the right hand side. The second on the arrangement of each side into categories, noncurrent, current. A balance sheet has two sides. The left hand side or the assets side lists all the possessions of your venture. And the right hand side its liabilities, including what it owes you the shareholders' equity. It's called a balance sheet because the two sides balance out. Even if the dictionary tell us that assets are the things your practice owns that have monetary value. My first tip is that you should think of total assets as the things your venture uses to operate its business. Uses is the keyword here. Intangible fixed assets and tangible fixed assets are assets held. With the intention of being used for the purpose of producing or providing goods or services. And are not held for sale in the normal course of business. Following this is a line called total non-current assets. Which adds the fixed assets to the current assets. Thinking of assets as the things your venture use to operate its business. Will help you understand why accounts receivable are listed as a current asset on the balance sheet. Accounts receivables are short term amounts due from customers. Who have purchased goods or services from your venture on credit. It is the use of funds, which allow your venture to sell to customers. Total assets measure all the uses of funds to operate your venture. On the right hand side, you find total liabilities. My tip is to interpret the liabilities side of your balance sheet as being the list of all of its financial resources. Here again, the dictionary tells you that liabilities reflect all the money your practice owes to others. And shareholders' equity, sometimes called net asset or net worth. Represents the money you would have left over. If you've sold your practice and all of its asset and paid off everything you owe. In simplified terms, total liabilities and total shareholders' equity are the two sources of fund that support these assets. Looking at the right hand side of the balance sheet as the various sources of fund employed in assets will allow you to understand why equity is on the liabilities side. Equity is the amount of capital, initially paid in capital, plus capital increases and accumulated profit or deficit. Equity can be negative if accumulated deficits are large enough. The word equity is a false friend. The company has no funds that belong to it. There is no money stashed under the name equity. The complete word is shareholders' equity. That is to say the money of shareholders. But even shareholders' equity is a false friend. You should understand that capital is never paid to shareholders unlike the debt repaid to creditors. The capital is the basis for the remuneration expected by shareholders, the dividend. The dividend is never fixed nor guaranteed. Equity is equal to assets minus liabilities. Total assets minus total liabilities equals shareholders' equity. That is what remained, theoretically, to shareholders if the company were wound up. Hence, the name in English, shareholders' equity. Debt is a loan to the company. That is usually repaid over the term of the loan or ultimately at maturity, in the case of what is called a balloon loan. The company pays a coupon to creditors regularly, usually every year for the long term debt. Short term debt is due within one year. And it includes credit discounting and financing of commercial transactions like factoring, for instance. A balance sheet shows all the uses of funds in a venture and lists the origin of its sources of fund. And now is my second tip on how to read your balance sheet. Let us start with the assets side. The things your venture uses to operate its business. According to accountants, there are two kinds of asset, current and non-current. Current assets are those that can be easily converted into cash. In a reasonably short period of time, specifically one year. In the same vein, the liabilities side contains current liabilities. That is to say source of funds that are due within 12 months. Non-current liability funds that are due later than 12 months, and shareholders' equity. This accounting definition might be misleading. Take the total value of your account receivables on the assets side. Remember that account receivables are short-term amounts due from customers. They're considered current because it is assumed that customer will be paying you soon, within a year. But the funds you will then receive will be used for new customers. Who will have purchased goods or services from your venture on credit. Account receivables are continually turned over in the course of a business during normal business activity. As a result and because of their cyclical nature, the funds used in account receivables are invested for an infinite period of time. But there are other cyclical accounts in the balance sheet. [MUSIC]
