Balance Sheet Explained

The Balance Sheet Explained: Interpreting the Balance Sheet

Are your assets and liabilities in check?

What does your personal balance sheet look like?

In the first part of the financial statements I explained what the income statement was and I gave an example of a snapshot of a real income statement to better illustrate and explain the income statement. Just like the income statement, the balance sheet is another very important document to search through and use for analysis of a good company to invest in. The Balance Sheet is a great document to analyze to find the financial strength, weaknesses, assets and liabilities of a company. Keep in mind that the balance sheet is not for current position of a company as the balance sheet is updated every quarter. But nonetheless, it is important to keep track off and watch how the balance sheet changes over time. The balance sheet is basically a snapshot of all assets and liabilities within a company. People can have personal balance sheets as well, as in the picture, you could ask yourself, “how much money do I have versus how much liabilities (like a car or house payment) do i have?”

What Makes UP the Balance Sheet?

 

A balance sheet is nothing more than a summary of assets and liabilities. One important thing to remember is that the accounting equation is assets equal liabilities plus equity. For example, on the asset side of the balance sheet you could have cash and on the liabilities side you could an I.O.U. if someone lent you the money. Let’s elaborate further, say you had $500 in cash and used it as start up capital. That would be considered owner’s equity and a asset. Now suppose you borrowed $800 from the bank to purchase an asset for the business, however the cost came out to $500 total. You would have $300 left over, the accounting equation would look like such:

Assets($500 Startup Cap in cash)+($500 Asset)+($300 Cash left over)= Liabilities ($800 loan)+Equity ($500 Owner startup Cap)

Assets=$1,300 and liabilities and equity=$1,300

 

Using the Balance Sheet for Investment Analysis

The balance sheet is a great place to look to find discrepancies and see how the management is using capital. If a company had $50,000,000 in a short term loan and only $2,000,000 in cash then it is a possibility that the company has too much debt and could risk going bankrupt if they are borrowing too much debt. On the flip side, if a company has $100,000,000 in cash and total liabilities, both short term and long term of $25,000,000 then management has utilized its capital wisely and is most likely a financially strong company. Another way to put this into perspective is to say, the company has a 4:1 ratio of assets to liabilities. Therefore the company has plenty of cash to pay off its debt and still have surplus to invest somewhere if need be. A ratio of 1:1 would indicate that the company has only enough assets to pay off debts and have nothing left, which in my opinion is just as bad as having too much debt. Think of it as your income: Say you make $1,000 a month and spend $1,000 a month. You would have no savings! What if you get in a wreck and have to pay to have your car fixed? What if you get hurt and need money for the emergency room? What if your child’s tuition for school is more than you thought it would be? The same principles are involved. A company with no savings is doomed for failure.

Conclusion

I hope this was insightful and that now you have a better understanding of what goes into the balance sheet. It is always a good idea to view the balance sheet to see where a company stands at a given point in time. Always be on the lookout for debt levels and that the company has enough assets to pay off the debt should an unforeseen event occur. Always due your own research and do not go by what others say until you have a complete understanding of how the company makes money and how they spend their money!

For more information view http://www.investopedia.com for insights into the balance sheet and financial information.

Stocks: What you should know before investing in stocks.

Wall StreetStocks. The word brings to mind images of Wall Street and bankers, wealth and power. But what exactly are stocks? You hear about them in the news or maybe you tune to a channel and see symbols run across the bottom of your screen during a commercial. You ask yourself, what are they talking about?

Most of the time when people hear about the “markets” on the news they are referring to the stock market. The stock market is a group of exchanges that list financial securities. To be accurate, the stock exchanges list other securities besides stocks, such as bonds, units and even derivatives. But before we get into all that lets focus on stocks.

Stocks are Businesses

So, you may be asking yourself, what are stocks? Stocks are financial securities that represent businesses. Every public company has stock listed on the stock exchanges. How do you find a company? If you want to look up a specific company you can just type in the ticker symbol in Google search.

For example, if you wanted to look up the stock price of Microsoft Corp you would type MSFT. Or if you wanted to know the price of Facebook’s stock it would be FB or Apple Inc, AAPL ect.

Stocks represent part ownership in a company. When you are buying stocks you are buying a piece of a business. In fact, stocks are also called shares. If you ever hear someone say they have shares in “xyz” it means they have stock in that company, its one in the same!

Apple Stock

Understanding the Basic Layout

The above picture is a snapshot of the stock app in the iphone. At first glance it may seem overwhelming but it is actually quite easy to understand once you learn the basic layout. We will start on the left side.

You will see a bunch of other ticker symbols, the price, and either red or green with a number inside the rectangular colored box. To  begin, it shows the Apple Inc ticker symbol, AAPL. Next is Apple’s stock price for that day, $665.18. Last is a negative 8.36, what this means is that Apple Inc stock has gone down $8.36 on that day. Below this is Apple’s stats.

“Open” is what Apple shares started at as soon as the stock exchanges opened for the day. The “high” and “low” show the highest and lowest price of the stock during the trading day or intraday if the exchanges have not closed yet. Below the high and low is “volume” which is the amount of shares that have traded hands from buyers to sellers throughout the day. (To the right is the volume average, the average volume level within the 52 week time frame.) Think of the volume as the amount of activity that a certain stock recieves. A higher trading volume means the stock is more liquid, which is good. Next, is the “P/E ratio”. The P/E stands for “price to earnings”, it is a basic way to measure how expensive or cheap a stock is. It basically says investors are willing to pay some multiple ” x” over the earnings of the business.

For Apple, the P/E ratio is 15.63 so investors are willing to pay about 16 times earnings or $16 for every dollar of Apple’s earnings. Because this is a ratio you can also tell what the earnings are if you reverse the equation. You can take Apple’s $665.18 price and divide it by the 15.63 to arrive at 42.55, it’s earnings per share.

On the right is market cap or market capitalization. This is what the company’s market value is, the share price multipled by all shares outstanding. It is what the markets assessment is of the company at any given time. As mentioned earlier, stock prices fluctuate throughout the day but over the long term it will reflect the true worth of the business. Notice how I said the market cap is not what the company is worth but what the market thinks it is worth. This is because sometimes the market misprices shares of a company, meaning it can trade at a discount or a premium. This is what Warren Buffet calls value investing, he finds companies who’s stock trades at a discount to its true value and buys them up before the market realizes and corrects the imbalance. But over the long term the true value will be reflected in the stock price.

The 52 week “high” and “low” shows the lowest and highest price of the stock during the 52 week time period. The “yield” is the dividend of the stock. A dividend is a payout to the stockholders of a company in the form of cash. Not all companies will have a dividend, but if it does you will have another form of compensation.  If you own stocks there are basically two ways to generate money or wealth. One is the price appreciation of the shares and the other is the dividend or yield. Keep in mind that not all companies give a dividend. As a stockholder you may like receiving money for holding on to your shares but there is a drawback. As I said a dividend is a payment to stockholders taken from company profits, but in doing so it means there is less money for the company to use to fund projects, to fund research and development or for expansion which means slower growth. However, if you are looking for income with price appreciation this is an option.

Stocks Power: Compound Interest

As I mentioned, there are two ways to generate money or wealth. Although they sound the same they are different. If you want money, buy dividend paying stocks. A company that issues a dividend will payout to the stockholders so you will receive money in your brokerage account every pay period.

Let’s look at Apple Inc again. Apple has a yield of 1.60% so with a stock price of $665.18 the dividend is $10.64 per year. Keep in mind that the dividend of most companies is paid out every quarter or four times a year. However, some may pay their dividend every 6 months or even monthly, it just depends on management.

However, the real power of stocks comes not from the dividend but from price appreciation. Although income investors may disagree, ideally you want most of your investment gains in the form of price appreciation. This is because over the years compounding takes effect. Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t… pays it.”

I want to help you become the person who understands it. Most people understand that the interest rate is the cost to borrow money but the interest rate can also be thought of as the rate of return on an investment. In today’s market the interest rate on savings accounts are at zero or close to it. In other words cash investments generate 0 or negative returns. Most bonds offer a 3-4% return but with the fed about to raise rates bonds will likely lose value. The best case is for stocks which have generated an average 6-7% over the past 50 years. Think about this that 7% return over 50 years will turn a mere $10,000 investment into almost $295,000! And thats with a one-time investment of $10,000. Imagine when you save and put more into investments! This is due to the effect of compound interest. Compound interest is when money is generated from interest. Instead of earning money off of your principal balance your money will start to earn money off of the new balance.

If you had $10,000 and it earned simple interest, it would only earn money on the principal balance and nothing more. Using the same example the $10,000 with a 7% return would only grow to be worth $45,000 after 50 years. That’s a $250,000 difference with continuous compound interest. That’s the power of stock investing. As long as you leave your investments alone, reinvest your returns and put more savings into investing you can really ramp up your retirement portfolio. This is why I urge everyone my age, millennials and the younger generations to start investing as soon as possible. The earlier you start and the longer you keep at it, the more money that will be earned in the later years of investing. Start now and watch your wealth grow over the years.

The Basics of Investing

Investing 101Now that we’ve covered how to develop the right frame of mind that will lead to success and how to save and budget your money lets talk about investing. Hopefully you have implemented a good budget and keep track of your expenses as well as your income sources. If you only have one source of income right now that’s OK. Investing is the secret driver to financial success.

It doesn’t matter how many jobs you have or how much you make a year. You can’t retire on working wages alone. This is especially true if you are making minimum wage or sub par wages or spending too much on non essentials. The way to financial freedom is to set up a system that pays you when you’re not working. What I’m talking about is residual or passive income. The best way to achieve this is to put money to work for you with investments.

There are several types of investments or investment vehicles:

  1. Stocks
  2. Bonds
  3. Real Estate
  4. Personal Side Ventures

I’m not going to get too much into detail with this post. This is just a basic rundown of the different kinds of investments there are so you can be aware of them. If you want further explanation or in-depth view stay tuned in for my upcoming posts.

Investing in StocksStock news

The main concept you must understand is that stocks are parts of a business. When you are buying stock or a share, you are buying a piece of a business. Many people trade stocks like they do with their iphones but I believe the best way to invest in Stocks is to take ownership. Think of yourself as a business owner instead of a trader.

Stocks can offer extremely high returns but be wary. If you do not know what you are doing you can lose out on a lot as well. Stocks tend to fluctuate in value rapidly but for the long term investor it can be worth your while. Please make sure you do your due diligence in researching on your own before you dive into investing in Stocks.

In any case, stocks can be very useful and a powerful weapon in your financial arsenal for the tax advantages as well as the effect of compound interest.

Investing in BondsI.O.U. paper

Bonds are a bit different from Stocks in that they don’t represent a share of a business. Instead, bonds are debt investments. A bond is basically an I.O.U. in which you give or lend money to a city, state or country.  In exchange for lending the money the entity agrees to pay a certain interest rate to you.The interest rate is basically a specific payout of your principal balance. Bonds are considered safer investments than stocks because the principal is preserved and you get a nice interest payout typically every six months.

To go with an example, say you bought a bond with a principal of $1,000. Now, lets say the bond has a interest rate of 3%, what that means is you will receive $30 a year or $15 every six months for the duration of the bond until the maturity date.  This leads to the next point, the maturity date. The maturity date is basically the life of the bond. Bonds can range in time durations from 1 to 30 years or longer. Once the bond reaches its maturity date the issurer of the bond will repay you the principal amount.

Investing in Real Estate

House sold sign

House sold sign

Now onto the next subject, ready?

Most people have probably heard stories of the succeses real estate investing. In fact, real estate is probably what most think of when they hear of people making investments. Well, real estate is just another thing to invest in!

But what most people are not aware of is the scope of real estate. To say your an investor in Real Estate is not specific enough. There are lots of ways to invest in real estate. Some of the more common ways to invest are flipping houses, owning rental properties or even owning reits.

Flipping houses is a far more tedious and laborious task as you have to buy a property for a good price, renovate it, a lot of times this means hiring contractors to fix up the property so you can resell the property later for a higher price than you paid. Keep in mind though that this way of investing requires a lot of time and money. You can expect most flips to take a few months and if your lucky, several weeks if you hire a lot of labor. However, this can be lucrative if you have the money and know the demographics well.

The other is owning rental property. This one is pretty self explanatory, you buy a property, whether that be a home or apartment building. Then you would rent it out to a person interested in the property. Just make sure that whatever rent you charge them is more than enough to cover your mortgage as well as basic repairs as they arise. Also be sure you know the area well because you want to be able to find an area with high occupancy rates. If not, you could buy a property only to end up paying the property taxes and upkeep, unable to find someone to rent to.

The third is more simpler and can be used by anybody looking into real estate. If you are short on money or don’t have the time to find and renovate houses reits could be your solution.

REIT stands for real estate investment trust. A real estate investment trust is a company that buys real estate assets things like commercial or apartment buildings and is listed on the public stock exchanges for people to buy “shares”. I put quotation marks because for reits they are called units. But reits are bought and sold just like publicly traded stock on the exchanges.

So if you are interested in owning real estate but don’t have the large funds or time to do so reits could be right up your alley. A good way to think of reits is a high yielding stock. Reits tend to have high dividend yeilds so it can become a good source of income.

Personal Side Ventures

The last way to make money is hustling on the side. Investing doesn’t just have to be about stocks, bonds or other financial securities. You could be investing your time into a side project that has the potential to generate money for you. In fact, if you are passionate about a particular subject you could take that idea and form a viable business plan and start earning another stream of income for yourself.

There are a lot of ways to make money beside your main job. You could sell something on the side or online. If your passionate and knowledgeable about a particular subject you could start a blog and monetize it to generate money via ads or affiliate links. Or you could even start a small business with a friend whom you trust and with the added benefit of not going it alone, you could pull resources together and have the business flourish to enable you to quit your day job if you wanted to do so.

Conclusion

There are many ways to make money through investments. If fact, the scope is so large I don’t know why more people don’t do it. There are lots of ways to make money outside your main job and no one is going to look after your well being more so than yourself. This is your life and you deserve financial freedom to do what you want in this life. Start today, make a plan and start having your money generate money for you!