Understanding the Income Statement, Balance Sheet, and Risk

-: Before we jump into this section, I wanna talk really quickly about risk and confidence. Let's kick it off with risk. "The biggest risk is not taking any risk. "In a world that is changing really quickly, "the only strategy that is guaranteed to fail "is not taking risks." Mark Zuckerberg, founder of Facebook. Confidence. We can do this. I saw this great movie called The Pursuit of Happyness. And there was this one scene where Will Smith is telling his son that he'll never amount to anything, and never be successful playing basketball. And it really resonated with me, thinking that you can really accomplish anything in life if you're confident. And he ends that scene by telling his son "Don't ever let somebody tell you you can't do something." If you get a chance, watch that movie, or go to YouTube and do a search on that scene, In the Pursuit of Happyness, when Will Smith's talking to his son, it's his real son in real life. It was very touching. And so, having a high degree of confidence will really help you be successful in life. Whether or not you think you can do it, you're right. Confidence, according to Vince lombardi, the very famous football coach in the United States, he said "Confidence is contagious, "so is lack of confidence." And I find that the best athletes I've ever met in my life are very confident, sometimes borderline arrogant, which is cool, but especially in a sport like baseball where you fail more often than not, the most confident hitters are the ones that excel. And so, when you're presenting to investors, just get into that peak mental state and be incredibly confident, because confidence leads to perceived competence. People think you're competent if you come across as confident in business. Especially in sales. Okay, so we're now going to talk about financial analysis and before I kick off this chapter, I want to tell you, and open up and be very honest with you, as always, that when I was younger, when I was at McGill University I took accounting and I got a D the first time. I got a D, because I was memorizing stuff. I was memorizing equations, I did well I guess in high school because I memorized stuff but university, you kind of have to understand stuff. And if you understand something, then you remember it. And so, I took the course again, and I did very well because I didn't memorize the second time, but I got a D the first time. I thought my life was over (laughs). Anyway, I want you to really understand and enjoy finance and accounting. And we're gonna start from scratch, here. I'm gonna assume you know nothing about accounting and finance, and if you already do, I'm very sorry if this session is boring for you. All right, let's do this. All right, so, we are on the third bar here. We're between years three and four. We got funded by Kleiner Perkins as well as Sequoia as well as an Angel investor, revenue growth is still kind of accelerating, you can see that. And so, today, we're gonna talk about financial analysis. Okay, so we're gonna start a company today. It's gonna be a hypothetical company. It's gonna be called Banana Watch. I know that's lame, it's corny, but we're starting a company called the Banana Watch. And we wanna register in every state, I think. Yeah, every state. So, let me ask you, would that be TM, trademark or R, trademark, or C, copyright? How do we protect our brand in every state? The answer is R, with a circle around it because TM, as we covered earlier, was just a couple of sentences. And copyright is protecting something that you can't see, feel or touch like music or software. Okay, let's move on. Again, don't memorize accounting or finance, okay? I want you to understand it, otherwise, you'll get a D in accounting, like I did, right? Okay, so let's talk about the first financial concept that I want you to know about, which is the balance sheet. Think of a scale, okay? And this scale kind of tracks everything you own or owe. So, a balance sheet just kind of tracks, what do you own? Or who owns your stuff? So, the balance sheet for my house might be that I own part of my house, and a mortgage bank owns part of the house as well. I own part of my car and Toyota owns a part of my car. So, those are the claims, so it balances. So, if you think about my car on a balance sheet scale, I own half of it and Toyota owns the other half, it kind of balances that way. So, a balance sheet just tells you what you own or who owns your stuff. So, let's go through it. So, a balance sheet, on one side is stuff you own and on the other side, it's the banks own your stuff or people that own your stuff, and when people own your stuff, that's called equity and when banks own your stuff, it's called debt. So, everything you own is either owned by banks or people, including you. I'll say that again, everything you own, so stuff you own is equal to the exact same amount, stuff you own, banks plus people who own your stuff. And that scale has to balance, okay? So, stuff you own is called assets, okay? This is the balance sheet, and debt that you owe, or people that have lent you money, whatever, that's called liabilities. You're liable to pay them back, right? Then the people that own your stuff, that's called equity. People who own your stuff include yourself. Capisce, good? Great. So, here it is. One side, the assets side is in green. And that's the left-hand side of the scale and the right-hand side of the scale is liabilities or debt and equity. So, let's go through the assets really quickly. Assets contain cash and stuff you can turn into money in less than a year. Stuff that is owned by us, inventory, equipment, buildings, stuff and liabilities is bills we have to pay, like to keep the lights on. Salaries we have to pay, or wages we have to pay, loans that are due in less than a year, and loans that are due in greater than a year. And equity is the amount of money that we own in our company or other people who own the company. So, assets can be broken down further, into current assets which is stuff you can sell in less than year, and long term assets, which is stuff that you can't sell in less than a year. Meaning it takes you more than a year to sell the stuff. Liabilities can be broken down as follows. Current liabilities is debt that you owe in less than a year like credit cards, and long term liabilities is debt that you owe in greater than one year like your mortgage. And then equity is just the people that own your stuff including you. And so, the assets have to equal liabilities plus equity. The scale's gotta balance, okay? So, assets, current assets equals cash because cash can be converted into itself (laughs) within less than a year, and treasury bills. So, say you're on treasuries or bonds. That kind of stuff, you can cash in, in less than a year in this example. And then, liabilities, or sorry. Long term assets is stuff like a factory. You see there's a factory there in that picture. That's a very famous album and somebody please, write in the comment section on this course what album cover that is for what band. I'll be really impressed, I'm dating myself here. I'm older than a lot of you, I'm sure, watching this. Okay, liabilities, current liabilities includes credit cards as well as payroll. You have to pay your employees in under a year. You've got to pay back a credit card in usually a month or less. Long term liabilities, in this case, let's assume it's banks, okay? I included mini banks and I mentioned this earlier, I'm gonna reinforce it again. You've always gotta make sure that if you deal with banks, and you shouldn't early on, but if you do later on in the lifecycle of your company, you've gotta deal with multiple banks. Small increments, why? Because you want those banks to compete. You want them to compete with you to give you the best rate possible. You want to keep them in check. Kind of like you'd never just have one employee responsible for everything because she or he could quit and you're screwed. Or she or he could ask for more money. You wanna have many employees with different tasks if possible. And then equity is just the people, including yourself, that own your assets, own your company. You'll notice that the left side, assets, has to equal liabilities and equities. So, $120k in this example equals $120, okay? There you go. So, how do we order the items on our balance sheet? Okay, so order these assets. So, you'll see by the way, that's a Canadian $5 bill, how awesome is that? Those are Canadian kids playing hockey. That rocks, it's the coolest thing ever, on the back of our $5 bill. Sorry, I digress. How do you order these things? Obviously, you'd order the cash first. The Canadian dollars, and then the American dollars. Canada always comes first, eh? Then you put the treasuries, and then your longer term stuff, you'd include your factory. The same thing with liabilities. You wanna order them the right way. So, the Ned Flanders, Homer Simpson credit card goes first. Because it's due within a month, and salaries probably do around the same time, right? You've gotta pay people every two weeks or every month. So maybe salaries first then credit cards. Then you've got short term loans, long term loans and leases. And so, what is a lease? What is this lease stuff you hear about all the time? Well, a lease makes sense to have. Think of it as renting something for a while, but there's tax benefits. What if I can't afford to buy a machine? Well, I can kind of rent or lease it. Or if I buy a machine then, what happens is, the debt will be so high because I have to finance it with debt that banks will get mad at me because I have a lot of debt. Or I don't want to deploy that much money to buying a piece of equipment. So, we're gonna rent it instead. Or, wait a second, that's the wrong machine, I've used it for two months. I wanna cancel that machine, so you can cancel the lease. That's easier than having to sell something you've bought. So, that is a balance sheet in a nut shell.