BUSINESS Demystifying Your Balance Sheet Our Sports Analogy In our football analogy, a quarterback player would establish a “total number of touchdowns” or “total number of passing yards.” For a running back, it would be “yards per carry.” Es- sentially, these are measures of their performance. Each player would have a performance score record for every game, a cu- mulative record for all games played thus far during the season and, ultimately, at the end of each season. As we’ve discussed, this is similar to how our income statement works because it covers performance for a period of time (one season), which can be thought of as a one-year business season. For the new/ next year, that seasonal record resets and begins anew. However, if we want or need to know how a player has per- formed on a cumulative basis — perhaps for several years or over a career — we need to look at his/her lifetime profes- sional record, from when they began through the most recent period. Thus, instead of looking at a one-season record (in- come statement equivalent), we need to look at the cumulative performance picture (balance sheet equivalent). The balance sheet covers the financial position/condition of the entity as of a moment in time or specific date, rather than performance for a season or period of time. For instance, we could say that Tom Brady just won the Super Bowl for the 2020 season (think income statement), but he has also amassed the best all-time record (think balance sheet) for Super Bowl wins, among other achievements. This is why he is referred to as a GOAT, or “Greatest of All Time.” Your Personal Income Statement Although not an ideal analogy, let’s forget about business and make believe you have a regular job and work for wages, where you might have to tolerate working for a boss just like you! I know, perish the thought! We’ll use your personal 2020 tax return to reinforce some of the key points, especially timing. Yes, I know, most of us would prefer to forget this particular bad boy and any reminders of all the 2020 virus stuff. On a fundamental level, this one-year tax return is sort of like your financial performance scorecard for the season/year of 2020. You’ll be recording how much money you earned in 2020 (mostly wages) and whichever expenses or deductions you are permitted to take that will reduce your taxable income. When you calculate what you earned (wages, interest income, dividend income, etc.) and then subtract the allowable deduc- tions and credits etc., you will have a number that represents your “adjusted income” and, finally, taxable income. That’s the number used to determine your tax rate and how much you owe or any refund you may have earned by overpaying. Gen- 20 KEYNOTES MAY 2021 erally speaking, you begin all over again for tax year 2021, and this is the same timing principle as your income statement for your business. The business details are more complicated, but don’t worry about that for now. It’s far more important that you grasp this “time period” difference between income statement and balance sheet. Your Personal Balance Sheet One of the best and most relatable ways I’ve found to explain the balance sheet concept is by building our own personal bal- ance sheet. Forget about the business stuff for just a moment and concentrate upon our personal financial situation. Let’s say that you are going to apply for a loan (perhaps a mortgage for your home), or maybe you just want to see how you’re doing with building your personal wealth (net worth) or how much more of your lunch money you need to save to make Fortune’s “World’s Richest People” listing. Whether you use a bank’s form(s), place your numbers in a spreadsheet or just scribble on the back of an envelope, the basic idea and calculations should be the same. Let’s keep this very simple so we can focus on the concept rather than the numbers or jargon. On a foundational level, there are three parts to this process. As of a certain date in time: 1. List the things that I “own” (some prefer to say “have,” “pos- sess” or “hold”) and calculate their respective numbers. 2. List the things that I “owe” to others and calculate their re- spective numbers 3. Formula: (1) minus (2) = (3) Calculate the difference. What I am worth financially is my equity. No, this has nothing to do with that time your boss referred to you as “completely worthless.” Let’s think about this in simple logical terms. You may “own” your house (you and your BFF silent partner, the bank or mortgage company), but you likely owe a balance on your mortgage. House market value $450,000 an asset (what you own or have or possess) Less mortgage balance $120,000 a liability (what you owe to others) Difference = $330,000 equity (your net worth financially) If you did not have any other assets or liabilities, we could say that your net worth is about $330K. Congratulations! You have WWW.ALOA.ORG
