Transaction #4 Carl’s First Sale - Balance Sheet

Just as Carl was about to call and order some clocks from his good friend Kim in China, he hears his doorbell ring. Grumpily Carl stalks to the door and answers it. To his surprise a nice, elderly lady from town is at the door and she wants to purchase his fine Swiss clocks. Carl pulls out his ten clocks and asks her which one she wants. Would you believe it? She wants all ten. The lady says that she has been looking for a gift to bestow upon her ten grandchildren and these clocks are just the ticket. The lady asks Carl how much money he wants for all ten clocks. Carl is still a bit taken back; this is his first sale and he really didn’t think he would sell them all at once. Carl reasons with himself that he bought the clocks for $5,000 and he should be able to get more back than that (if not, then why is he in business?). He tells her $7,000. The lady hands him $7,000 worth of $100 bills. Carl thought it was a bit odd that she was carrying that much cash so he pulls out his trusty counterfeit money pen and sure enough all the bills are legitimate. He thanks her and they part ways.

Carl's balance sheet after his first sale.

Carl quickly puts the $7,000 in cash in his money box. Now Carl has $12,000 in cash all assets ($5,000 from dad and $7,000 from his most recent sale). Carl still owes his dad $5,000 (a liability). He also has the $5,000 in common stock that he initially invested himself. That only adds up to $10,000. Where does the other $2,000 go? The answer is retained earnings.

When Carl sold the ten Swiss watched he sold them for $2,000 more than what he bought them for. This means Carl made a $2,000 profit on the watches. At this point Carl has a choice. He can go and spend the $2,000 on personal items or he can keep the money in the business. Carl wants his business to grow so he decides to reinvest the $2,000. When owners reinvest their profits or earnings into their business this is known as retained earnings.

It’s worth noting that business owners can really provide assets to a company in two ways:

(1). They can contribute money in exchange for stock ownership. This stock ownership is reflected on the balance sheet under the name common stock, contributed captial, or capital stock. This is what Carl did when he invested his $5,000.

(2). They can reinvest any profit or earnings they receive from running the business. This is known as retained earnings.

Transaction #5 Carl’s Clockworks First Dividend

If Carl’s first love is everything related to clocks, his second love is watching the television. Up until now all Carl could afford was a small 19 inch television. Carl is now riding high with $12,000 of cash in his business box and he decides it is time to upgrade his television. Carl decides to make a $1,000 cash withdrawal from his business in order to buy a 46 inch LCD TV. This is perfectally legal and most businesses withdraw money for personal use from time to time. When a business takes money out like this, it is called a dividend.

Let’s take a look at how Carl’s business is looking on paper after this dividend.

Carl's Clockworks financial position after the dividend.

Carl now only has $11,000 in cash (assets). The question is where should he deduct this $1,000 from on the right side of the equation. Liabilities or owners equity? Well he hasn’t paid off any of his $5,000 loan so Carl will have to deduct the $1,000 from owners’ equity; in this case from retained earnings.

That sums up the introduction to the balance sheet. Carl has learned a lot. He realizes that the balance sheet, or statement of financial position, shows all the assets, liabilities, and owners’ equity of a company. He’s feeling pretty good about himself. In the next lesson Carl takes on the income statement.

Next Lesson: Lesson 4 – Introduction to the Income Statement

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