It's Tuesday morning - and what could be more fun than reading a little bit about homebuilding accounting!?! I know - right????
In the last two emails, I wrote about Assets (the "good" stuff you want more of) and Liabilities (the "stuff you owe to others").
And those two things are found in a Balance Sheet - one of the financial reports you should take some time to understand.
But - there's one more major item on the Balance Sheet that you should know about: Owners' Equity.
Owners' Equity starts with any money that the Owners put into the business. So, on Day One, that amount IS the current Owners' Equity.
Then - as the company goes through it's first year of business - any Retained Earnings are added to that beginning balance to come up with the NEW current Owners' Equity.
Wait a minute!! What the heck are Retained Earnings? I knew you might ask that.
Retained Earnings is the amount of cash that is left over at the end of a fiscal period from doing business that hasn't been paid out to Owners (you know - bonuses, draws, etc.).
In a good year - which is what you want - there IS cash left over. And that positive Retained Earnings + Owners' Initial Equity = MORE Owners' Equity.
Of course, in challenging years - when you've, um, lost some money, that negative Retained Earnings + Owners' Initial Equity = LESS Owners' Equity. Boo!๐
And that's an overly simplified description of Owners' Equity - but - one that I think is important for "non-finance" people to understand.
As mentioned earlier, you see the following three things on a Balance Sheet:
- Assets
- Liabilities
- Owners' Equity
And knowing the total balance of each of these sections on your Balance Sheet, you can make sure that your accounting is, um, balanced.
Time to put on your third grade math class hat, because you need to know that two sides of a formula have to balance.
Here's the simple Balance Sheet formula:
TOTAL ASSETS = TOTAL LIABILITIES + OWNERS' EQUITY
2 = 1 + 1
Hope this helps for the day. Have a great week of building!
-Brad