 Hello and welcome to the session in which we will discuss the balance sheet or some time known as the statement of financial position This topic is covered on the CPA exam Which is this is why I have it as CPA exam bootcamp part one of three because you need to understand the overall picture of a balance sheet and Is also covered in intermediate accounting usually chapter three or chapter four in your textbook. We'll talk about the financial statements now in this session will give you an overview about About the balance sheet and what I'm gonna do I'm gonna take each section and dive deep a little bit deep into it For example, we'll take the assets break them them into current and noncurrent will do the same thing for liabilities and equities But this is an overall picture about the three sections of the balance sheets Which are assets one liabilities and stockholders equity before we proceed any further I have a public announcement about my company far hat lectures dot com Far hat accounting lectures is a supplemental educational tool That's gonna help you with your CPA exam preparation as well as your accounting courses My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles My accounting courses are aligned with your accounting courses broken down by chapter and topics My resources consist of lectures multiple choice questions through false questions as well as exercises Go ahead start your free trial today. So what does the balance sheet tells us? Well, it report our assets, which are our resources cash investments receivable Inventory someone and so forth building land it shows us our liabilities Which is our obligation? How much money do we owe to other people in terms of borrowing in terms of accounts payable in terms of accrued liabilities? We have all the payables here and The difference between those is called net assets mine asset minus liabilities equal equity, which is the same thing as net asset Net asset mainly shows us two things Well, the difference between asset and liabilities indeed But that's represented by how much the investor invested in the company Which is common stock and paid in capital common stock and paid in capital or common stock or capital stock and Retained earning which is how much the company made and earned over the years So this is an overall picture of the three sections. What are the usefulness of the balance sheet? So as a balance sheet, how good is it for us as? Investors as creditors as business analysts. Well, the first thing is it shows us the capital structure of the company What is the capital structure the capital structure shows us? How much of our assets is financed by that how much of our assets is financed by equity? So notice we have almost five million an asset 4.997 notice now we need to know how much of that is financed through that well of the five We have two point nine six eight million of liabilities and Remaining two million in debt. So notice here in this company the capital structure If you really want to have a rough estimate if we take two point nine divided by four point nine Approximately approximately 59% of our asset is financed through equity so from from the balance sheet You could immediately see that this company relies more on that that's their capital structure and because of that it's gonna help us assess the risk of the company and it's a future cash flow generally speaking the More that you have if you rely more and on that you are a riskier company and because you're a risky company Why are you a risky company? Let's let's talk about why that is risky that is risky because when you have that You have to pay your interest. You have no option. So you have what's called the pressure on your cash flow Therefore you become riskier if you have that that's why more that means more risk on the other hand If you have if you are relying more on equity, you don't have to pay You don't have to pay your stockholders dividend if you don't make a profit But for that you have to pay that interest whether you have a good time or bad time Now bear in mind the balance sheet is as a specific date notice here December 31st at 20x5 What else can the balance sheet shows us more specifically? It can anal it help us analyze what we called the company's liquidity and what is liquidity? Liquidity how quickly assets can be converted into cash when we talk liquidity We're talking about can the company survive in the short term liquidity means in the short term How quickly can you convert your asset into cash in order to pay your current liabilities because that's the immediate pressure? Why is that important? Well, if you're a creditor You want to know if you're gonna lend this company if you're gonna sell them on account if you're one of their suppliers How willing are you to do so? Well the balance sheet will tell you you would run some you would run some ratios and Kind of assess their liquidity also as an investor. You're interested in cash well You analyze the company from a liquidity perspective Which is we have more lessons about how to do so through ratios and you will assess whether it's a good investment or not If you want to rely on dividend So that's another feature that the balance sheet could tell us is the liquidity Also, it could tell us about the solvency. What's the difference between solvency and liquidity? Solvency is looking in the long term. Can we survive in the long term? Do we have the ability to pay our long-term debt as they become due because notice we have current liabilities and we have long-term Liabilities the long-term liabilities need to be paid. Well We can run some ratios to figure out. What is the company solvency and the balance sheet would help us do so Well, if we can't survive in the long term, we're not a viable company. We are a risky company What else can the balance sheet tells us it could tells us about our financial flexibility and what's financial flexibility? It's liquidity and solvency combined. Basically, you're looking at the overall picture if a company is loaded with debt It means it has less flexibility whether that debt a short term or long term now short term That is riskier because you have to come up with the cash soon long term that you have little bit more time But nevertheless, they are both pressure. They're put pressure on your cash on your cash flow and companies if they have a lot of debt and Suddenly we have a financial crisis like covid or like the financial crisis of 2007 2008 They will not be able to survive a case in point a general motor a general motor did not survive the 2007 2008 financial crisis why because they had so much debt and they did not have enough cash on hand So when their sales slow down, they could not survive versus for they were little They had a little bit more of a cushion and they were able to survive So that's why that is important because in that time that is risky, especially in Slowdown higher flexibility means lower risk when you have less that it means you have more options You want flexibility why because when an opportunity comes you have a good buy You can buy another company. Well, if you don't have a lot of that you can borrow to buy this company So you have higher flexibility, which is gives you lower risk because you have a cushion you're flexible You can survive if something happens. So this is all the good stuff about the balance sheet Now obviously we're gonna look at each account in the balance sheet and details In various sections now the balance sheet is great, but it has its own limitations What are some of the limitations of the balance sheet one? It use historical cost now not all accounts use historical cost But many accounts on the balance sheet use historical cost like land building when you buy them equipment You record them at historical cost and usually you keep them at historical cost, but the trend now is to Stay away from historical cost. The trend is stored fair value. For example, your investment now are Recorded at fair value your account receivable is recorded at net Realizable value, it means how much can you get how much can you receive from the account receivable? for example, your inventory is Reported at your lower of cost or market So notice there is a trend of bringing more relevant Valuation to the balance sheet but but most assets not most not all assets use historical cost But still a large proportion use historical cost which is meaningless for us But as an investor's users, we can take the historical cost as a starting figure Another limitation of the balance sheet just like it's a limitation in accounting in general is we use a lot of estimates and Judgment for example account receivable What we do is we estimate Bad debt which is From a balance sheet perspective. We estimate the allowance for doubtful account. That's an estimate figure Warranty liabilities if we have liabilities we estimate The warranties same thing with accumulated depreciation Accumulated depreciation is a form of estimate is a form of estimate because when you estimate the life of an asset Well, that's an estimate. Well, that estimate might be wrong. That estimate might be Right, but nevertheless, it's an estimate. You're taking a risk Also, the balance sheet don't capture certain value of the company. For example, if the company they have a good management system For example, excellent employees That does not reflect on the balance sheet if we take a company like Tesla I would say their most important asset is Elon Musk Well, if you look at the balance sheet Elon Musk don't exist because the balance sheet don't capture The value of your employees also the balance sheet don't capture the value of the company's reputation Maybe your reputation is what really bringing you sales not your actual asset. You look at the balance sheet Well, reputation is an asset, but it doesn't reflect on the balance sheet. So it's a soft asset Now we're gonna do we're gonna look at the various elements real quick from an overall perspective of the balance sheet And the elements of the balance sheet are assets, which are the resources of the company cash inventory receivable prepaid Property plant and equipment intangible those have economic value or future benefit Okay, and assets will be breaking down and we're gonna look at various sections into a current section long-term investment section Property plant and equipment intangible and other assets most companies They have four sections sometime you have fifth section if something doesn't fit in the four sections You just have another section called other assets That's fine and we're gonna look into each of these assets separately and In the next slide breaking them down. The other section is liquidity liquidity or not liquidity liabilities which will help with liquidities a current obligation or Or a debt as a result of fast transaction would which will require future sacrifice of asset usually cash Liabilities usually broken down into two parts current liabilities and long-term liabilities again in the next section We will cover current liabilities and long-term liabilities And the third section is equity, which is what as we said its asset minus Liabilities, which is the difference is equity now under equity usually the two main components of equity Are common stock and when we say common stock include additional paid-in capital, which is what the investors paid into the company and another account called retained Earnings and retained earnings is what the company earned and kept over the years those two are the main Component of stockholders equity. We have many many others. We're gonna have one whole chapter about equity That's not the point, but I'm giving you an idea about what's the main component of equity? So notice we have three sections as we started in the balance sheet Assets, which is the first section liabilities is the second and owners equity is the third again We're gonna have we're gonna dive into each section then we're gonna dive into each account in each of these section Separately, what should you do now go to far hat lectures look at additional resources? Lectures multiple choice exercises true false and the notes to help you understand this concept better whether you are a CPA candidate a financial accounting students a CMA candidate Understanding the balance sheet is critical for your success. Good luck study hard and of course stay safe