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The Balance Sheet. Sister BEE’s Shop. Mee’s Sister BEE Wants a Business, too. Oh, no! I bet this is going to cost me some money….
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The Balance Sheet Sister BEE’s Shop
Mee’s Sister BEE Wants a Business, too. Oh, no! I bet this is going to cost me some money….. Bee, What kind of shop? Where? I mean, you’ve never had a business before. You don’t know anything about management or bookkeeping. You haven’t even had a job before. …Have you given this any thought? OK, OK my precious lovely daughter. Anything you want. Just give it some thought and let me know what you decide. Wah, Wah… I knew that you would say NO! I know you don’t love me. Wah, Wah… Dad, it’s not fair. Mee’s getting rich with his moto taxi business, but I don’t have anything. I want to have a shop. I want to be the boss! Ugh, um….BEE, my favorite daughter. What do you have in mind? The next weekend, BEE has found a shop she wants to rent. Her Dad “lends” her 30,000 baht to get started. …. Now DAD’s the one who is crying.
BEE Sets Up Shop With 30,000 baht of her Dad’s money in her pocket, BEE rents a shop (6 month lease) and gets it ready to open. Here comes Dad’s money… And there it goes….. With only 2,500 baht left, let’s look at exactly what has happened….
Analyzing Money Out Just because BEE’s cash has mostly “disappeared” doesn’t mean the she and her shop don’t have anything. Things that a business has that are of positive value are known as ASSETS. Assets can be either physical (e.g. a chair) or financial (e.g. cash). Money spent to operate a business, with no offsetting Assets, are EXPENSES. * The Expenses here are just like MEE’s expenses for his motorcycle taxi business.
BEE’s Cash Flow Statement BEE started with 0, added 30,000 baht, and ended with 2,500 baht, so let’s see what happened… We already have Cash Flow From Operating Activities, which show cash used or gained for normal day-to day-business. Now, we have to introduce Cash Flow From Financing Activities, which shows cash used to pay for the business, or given back to lenders and investors. Then, we have to introduce Cash Flow From Investment Activities, which shows use cash used to buy assets that we will keep for a long time to make the business work. So let’s see what happened to the money…
More Assets, Less Cash Notice on the Cash Flow Statement that increases in assets lead to decreases in cash. More Assets Less Cash
The Balance Sheet Assets Liabilities First, BEE spends 4,000 baht on a refundable deposit, plus a total of 8,000 baht on first and last month’s rent. The Cash goes down, but other assets go up! Cash 14,300 Cash 18,000 Cash 30,000 Cash 5,000 Cash 26,000 Then BEE spends 3,700 on Furniture (part of “Property, Plant &Equipment”, or P,P&E for short). So far, so good! But … What about the 2,500 baht spent on fixing the shop???? And then Bee spends 9,300 on things to sell (“Inventory”) And now the business has 30,000 baht in Cash (Asset)! Watch what happens when the first 30,000 baht is invested…. Inventory 9,300 Owners’ Equity Refundable Deposits 4,000 Pre-Paid Rent 8,000 Capital Paid In 30,000 P,P&E (Furniture) 3,700 BEE has invested 30,000 baht in the business ….. Total A = 30,000 Total L + OE = 30,000 Always! Assets = Liabilities + Owners’ Equity ……..
Before we look at the money spent on fixing up the shop, think about the following …. By looking at the balance sheet, do we know how or where BEE got the money to invest in this business? NO !!! And we don’t care !!! But let’s consider another possibility. What if BEE had invested 4,000 baht in the business, and DAD had loaned 26,000 TO THE BUSINESS…..not to BEE personally. Now we care !!! Look how the Balance Sheet would change…
Alternative Scenario: BEE invests 4,000 baht and DAD loans the business 26,000 baht. Assets Liabilities Cash 4,000 Cash 30,000 Loan (from DAD) 26,000 Owners’ Equity First, BEE invests 4,000 baht to start the business. Next, DAD loans the business 26,000 baht. Paid In Capital 4,000 Total A = 4,000 Total A = 30,000 Total L + OE = 4,000 Total L + OE = 30,000
More Liabilities, More Cash Notice on the Cash Flow Statement that increases in Liabilities lead to increases in Cash. More Liabilities MoreCash
Now, back to the question…. What do we do about the 2,500 baht spent fixing up the shop? Return to the earlier situation, where BEE has invested 30,000 baht, and has recorded her purchases. This is an Expense! Expenses are recorded on the Income Statement. Therefore, we need to relate the Balance Sheet to the Income Statement.
Income Statement So what happens? But we are not done! What about the Balance Sheet ? Cash Expenses - 2,500 - 2,500 Balance Sheet Assets Liabilities We now need to record the 2,500 baht spent to fix the shop. This is a general expense not associated with a sale. It is not an asset because it has no value to BEE once she leaves the shop. The Retained Earnings account shows how much profit the business has made, which has stayed in the business (as opposed to being taken out of the business by its owners). Cash 5,000 Cash 2,500 We need to introduce an Owners’ Equity account called “Retained Earnings”, which comes from the accumulated profits or losses on the Income Statement. At the end of the year, when the income accounts are closed, the Net Income will be transferred to Retained Earnings. Inventory 9,300 Refundable Deposits 4,000 Owners’ Equity Pre-Paid Rent 8,000 P, P & E (Furniture) 3,700 Paid-In Capital 30,000 Retained Earnings - 2,500 Total A = 30,000 Total A = 27,500 Total L + OE = 30,000 Total L + OE = 27,500
To continue with this example, let’s suppose that BEE has opened a dress shop. BEE decides to mark up everything by 50% above cost. For example, if she buys a shirt for 120 baht, she sells it for 120 x 1.50 = 180 baht. If BEE sells 3,200 of inventory (for 3,200 x 1.50 = 4,800 baht), what happens to the Income Statement and Balance Sheet?
Income Statement 4,800 - 3,200 = 1,600 - 2,500 = - 900 = - 2,500 Balance Sheet Assets Liabilities To repeat, the Income Statement consists of temporary accounts that are closed out (re-set to zero) at the end of each accounting period. It is then that Net Income gets transferred to Retained Earnings. More on this later. Cash 7,300 Cash 2,500 Let’s do the Income Statement first. Sales are 4,800 baht from inventory which cost 3,200 baht. On the right-hand side, the Retained Earnings account has increased by 1,600 baht, to – 900 baht only. Inventory 6,100 Inventory 9,300 What has happened to the Balance Sheet? On the asset side, we have more Cash (4,800 baht) and less Inventory (3,200 baht) Refundable Deposits 4,000 Owners’ Equity Pre-Paid Rent 8,000 P, P & E (Furniture) 3,700 Paid-In Capital 30,000 Retained Earnings - 2,500 Retained Earnings - 900 Total A = 29,100 Total A = 27,500 Total L + OE = 29,100 Total L + OE = 27,500
Finally, let’s suppose the first month has ended. BEE’s pre-paid rent for the first month has now been spent, and must be recorded on the Income Statement. Of course, now she must pay (in advance) for the second month’s rent. How are these transactions recorded ?
Income Statement 4,800 - 3,200 = 1,600 - 6,500 - 2,500 - 4,900 = - 900 Balance Sheet Assets Liabilities Once again, cash goes out but pre-paid rent (an Asset) goes up….until the rent is used up…at which time it becomes an Expense. Cash 7,300 Cash 3,300 BEE has used one month – the first month - of rent that she had pre-paid for. It is no longer an Asset. It is used up. It is now an Expense. Inventory 6,100 Now we have to take care of the balance sheet. First the left side, then the right side. What happens when BEE pays her second month’s rent (in advance) ? Refundable Deposits 4,000 Owners’ Equity Pre-Paid Rent 8,000 Pre-Paid Rent 4,000 P, P & E (Furniture) 3,700 Paid-In Capital 30,000 Retained Earnings - 900 Retained Earnings – 4,900 Total A = 25,100 Total A = 29,100 Total L + OE = 29,100 Total L + OE = 25,100