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The best way to understand a balance sheet is to construct one yourself.

So, let's construct a balance sheet in this session.

Let me introduce an imaginary company called The Pen Company.

Let's talk about this company's financial activities in year one.

So, an entrepreneur starts Pen company with $3,000 of cash,

and $4,000 in loan.

She purchases a production equipment,

with a cash of $4,000.

In action three, she purchases raw materials for $3,000 on credit.

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She pays herself a salary of $1,000.

And in the last action at the end of the year,

she depreciates production equipment by 20 percent.

So, these eight actions

summarize the financial activities of the Pen company in year one.

And we will use this example later for other financial statements,

so, please make yourself familiar with these actions.

Okay, so let's construct the balance sheet for a Pen company,

at the end of year one.

In action one, the entrepreneur starts Pen company with $3,000 cash and $4,000 in loan.

So, at the end of action one,

the company has $7,000 in cash.

Three thousand of this is owners equity,

and $4,000 is a loan.

So the action one will look like this on the balance sheet.

So the company has $7,000 in cash on the left side of the balance sheet,

on the right side,

it shows how she obtained the money.

Four thousand dollars in cash,

and $3,000 is an investment money.

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In action two, she uses $4,000 of cash,

to buy a production equipment.

So, there will be a decrease of cash by $4,000.

But, now she has equipment with the same value.

There's no change on the right side.

So, if you were to calculate line one,

and line two, that's the balance sheet after action two.

Now, she has $3000 of cash,

and $4,000 of equipment,

and there's no change on the right side.

So, right side and left side, still balance.

In action three, she purchases raw materials on credit.

So, there's no change in cash.

Now, she has matured inventory of $3000,

and, now she has accounts payable.

Because, she has to pay back these accounts payable.

So, it looks like this 3,000 on material inventory,

and again 3,000 as accounts payable.

So again, this balance sheet balances.

In action four, she does production.

So she uses $2,000 of raw materials,

and she pays labor costs.

So, there is a decrease of cash by $500,

and decrease of mature inventory by $2,000.

But, now she has finished goods inventory of $2,500,

and there's no change on the right side.

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In action five, she sells all the products for $5,000,

she receives one half cash.

So, there is an increase of $2,500 in cash.

Now, she has accounts receivable of $2,500.

So, it will look like this.

She used them all the finished goods inventory.

So, with this transaction,

she generates $2,500 of profit,

and that goes to owners equity.

So from this, we know that balance sheet shows

the financial status of a company at a certain moment.

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So, let's look at action six.

She pays all the accounts payable,

which is a $3,000,

and also the interest on the loan which is 10 percent of $4,000, that's $400.

There's a major decrease of cash by $3,400,

and decrease of $3,000 in accounts payable,

and decrease of owners equity by $400.

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Then, in action seven,

she pays herself a salary of $1,000.

And so, there is a decrease of cash by 1,000,

and decrease of owners equity with the same amount.

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So, the equipment value will be decreased by $800.

There should be a same decrease in owners equity.

So, we have constructed the balance sheet of Pen company at the end of the year.

That last line is the balance sheet at the end of the year one.

So, I write this balance sheet at the end of the year.

And there are current assets like cash,

accounts receivable, and material inventory,

and the total is $4,100.

There are fixed assets,

and the purchase price was $4,000,

and we depreciate that by $800.

So, the remaining value for the equipment is $3,200.

So, the total assets is $7,300.

And on the right side,

there is a loan for $4,000,

and owners equity $3,000,

plus retained profit of $300.

So, we will check this profit again,

when you construct the income statement.

So the total liabilities,

and owners equity is again $7,300.

So, left side and right side balance.

In summary, balance sheet shows a company's financial state at a certain moment.

And we now know that the balance sheet always balances.