FINANCIAL LITERACY “Financial literacy is one of the most important investor basics, especially if you want to be a safe investor, an inside investor, and a rich investor. Anyone who is not financially literate cannot see into an investment. Just as a doctor uses X-rays to look at your skeletal system, a financial statement allows you to look into an investment and see the truth, the facts, the fiction, the opportunities, and the risk. Reading a financial statement of a business or individual is like reading a biography or an autobiography. ” A business has a financial statement, a stock certificate is a reflection of a financial statement, each piece of real estate has a financial statement, and each of us as an individual human being has a financial statement attached to us…Everything – regardless of if it is a business, real estate, or human being – that transacts money has an income statement and balance sheet, whether or not they know it. People who are not aware of the POWER OF A FINANCIAL STATEMENT often have the LEAST MONEY and the BIGGEST FINANCIAL PROBLEMS. ” “While you were in school, you got a report card once a quarter.Order now
A financial statement is your report card once you leave school. The problem is that since most people have not been trained to read financial statements or how to keep a personal financial statement, they have no idea how they are doing once they leave school. Many people have failing marks on their personal financial statements but think they are doing well because they have a high-paying job and a nice home. Unfortunately, if I were handing out the grades, anyone who was not financially independent by age 45 would receive a failing grade. It’s not that I want to be cruel.
I just want people to wake up and maybe do a few things differently…before they run out of their most important asset: TIME! ” “A person needs to get his or her own personal financial statement under control before investing. ” “This process I have been talking to you about is the process of taking control of yourself, which also means your financial statement. So many people want to invest because they are deep in debt. Investing in the hopes of making more money so you can pay your bills or a buy a bigger house or a new car is a fool’s investment plan.
You invest for one reason: to acquire an asset that converts earned income into passive income or portfolio income. That conversion of one form of income into another form of income is the primary objective of a TRUE INVESTOR. And to do that requires a higher degree of financial literacy than simply balancing a checkbook. ” “So you’re not concerned about the price of a stock or piece of real estate. You’re more concerned with the operating fundamentals, the fundamentals that you can see with a financial statement? ” Where you find the best investment opportunities is from understanding accounting, the tax code, business law, and corporate law. And it in these invisible realms where the real investors shop for the biggest investment bargains. ” “People leave school not even knowing how to balance a checkbook much less how to prepare a financial statement. They never learned how to control their finances. And the only way you can tell if people are in control of themselves is by looking at their financial statements. ” “Just because people have high-paying jobs, big houses, and nice cars does not necessarily mean they are in control financially.
If people knew how a financial statement worked, they would be more financially literate and more in control of their money. By understanding financial statements, people can better see how their cash is flowing. ” Literacy Lesson #1: It is the direction of cash flowing that determines if something is an asset or a liability, at that moment. In other words, just because your real estate broker calls your house an asset does not mean it is an asset. Literacy Lesson #2: It takes at least two financial statements to see the entire picture. Sophisticated Investors must see at least two financial statements simultaneously if they want a true picture. ” “…the professional investor must think beyond the price of an investment going up or going down. A sophisticated investor reads the numbers to get the true story and begins to see things that the average investor does not see. A sophisticated investor must see the impact of government regulations, tax codes, corporate law, business law, and accounting law. One reason it is hard to find accurate investment information is that to gain a full picture requires financial literacy, an accountant, and an attorney.
In other words, you need two different professionals to get the real picture. The good news is that if you take your time and invest the time to learn the ins and outs of what goes on behind the scenes, you will find investment opportunities and great wealth, wealth that very few people ever find. You will find out the truth about why the rich get richer, and the poor and middle class work harder, pay more in taxes, and get deeper in debt. Once you know the truths, you can then decide which side of the quadrant you want to operate from.
IT’S NOT HARD; IT JUST TAKES SOME TIME…TIME THAT PEOPLE WHO JUST WANT A HOT INVESTMENT TIP DO NOT WANT TO INVEST. ” “When you come to the boundaries of what you know, it’s time to make some mistakes. ” “The streets are a very tough teacher. In school, you’re given the lesson first. On the street, you’re given the mistake first and then it’s up to you to find the lesson, if you ever find it…in school, you are considered smart if you don’t make mistakes. On the street, you’re smart only if you make mistakes and learn from them. ” – On School Smarts and Street Smarts. I am so rich because I’ve made more financial mistakes than most people. Each time I made a mistake, I learned something new. In the business world, that something new is often called ‘EXPERIENCE. ’ But experience is not enough. Many people say they have a lot of experience because they keep making the same mistake over and over again. If a person truly learns from a mistake, his or her life changes forever, and what that person gains instead of experience is ‘WISDOM. ’ “People often avoid making financial mistakes, and that is a mistake. They keep saying to themselves, ‘Play it safe. Don’t take risks. People may be struggling financially because they have already made mistakes and have not learned from the mistakes. So they get up every day, go to work, and repeat the mistake and avoid new mistakes, but they never find the lesson. These people often say to themselves, ‘I’m doing everything right, but for some reason, I’m not getting ahead financially. ’ “There are people who buy tickets to the game, and there are people who sell tickets to the game. You want to be on the side that is selling the tickets. ” “Great spirits have often encountered violent opposition from mediocre minds. – Einstein “We all possess both a great spirit and a mediocre mind. The challenge in turning our ideas into a million dollar or even a billion dollar asset is often the battle between our own great spirits and our own, often mediocre, minds. ” – Rich Dad “There are many people with great ideas but very few people with great amounts of money. The reason the 90/10 rule holds true is because it does not take a great idea to become rich but it does take a great person behind the idea to become rich. You must be of strong spirit and strong in your convictions to turn you ideas into fortunes.
Even if you understand the process via which your ideas can become millions even billions of dollars, always remember that great ideas only become great fortunes if the person behind the idea is also willing to be great! It is often difficult to keep going when everyone around you is saying, “You can’t do it. ” You must have a very strong spirit to withstand the doubt of those around you. But your spirit must be even stronger when you are the person saying to yourself “You can’t do that. ”…No one can tell you what you can or cannot do in your life. Only you can determine that.
Your own greatness is often found at the end of the road, and when it comes to turning your ideas into money, there are many times when you come to the end of the road. The end of the road is when you are out of ideas, out of money, and filled with doubt. If you can find in yourself the spirit to go on, you will find out what it really takes to turn your ideas into great assets. Turning an idea into a great fortune is more a matter of human spirit rather than the power of the human mind. At the end of every road, the entrepreneur finds his or her spirit.
Finding your entrepreneurial spirit and making it strong is more important than the idea or business you are developing. Once you find your entrepreneurial spirit, you will forever be able to take very ordinary ideas and turn them into extraordinary fortunes. Always remember the world is filled with people with great ideas and very few people with great fortunes. ” – Rich Dad Once you understand the fundamentals of investing, you can better understand rich dad’s categories of investors and the ten investor controls he said were important to all investors: The Ten Investor Controls . The control over yourself 2. The control over income/expense asset/liability ratios 3. The control over the management of the investment 4. The control over taxes 5. The control over when you buy and when you sell 6. The control over brokerage transactions 7. The control over the ETC (entity, timing, and characteristics) 8. The control over the terms and conditions of the agreements 9. The control over access to information 10. The control over giving it back, philanthropy, redistribution of wealth “Investing is not risky; not being in control is risky. – Rich dad Many people find investing risky because they are not in control of one or more of these ten investor controls. The Inside Investor To build a successful business is the goal of the inside investor. The business may be a single piece of rental real estate or a multi-billion –dollar retail company…A successful B knows how to create and build assets. Rich dad would say, “The rich invent money. After you learn to make your first million, the next ten will be easy. ” A successful B will also learn the skills needed to analyze companies for investment from the outside.
Therefore, a successful inside investor can learn to become a successful sophisticated investor. The Ultimate Investor To become the selling shareholder is the goal of the ultimate investor. The ultimate investor owns a successful business in which he or she sells ownership interest to the public; hence, he or she is a selling shareholder. If you want to invest in the same investments the rich invest in, you need: 1. Education 2. Experience 3. Excessive cash The price of being financially free requires time and dedication to gain the education, experience, and excessive cash to invest at those levels.
You know you are financially smarter or increasing in sophistication when you can tell the differences between: 1. Good debt and bad debt 2. Good losses and bad losses 3. Good expenses and bad expenses 4. Tax payments versus tax incentives 5. Corporations you work for versus corporations you own 6. How to build a business, how to fix a business, and how to take a business public 7. The advantages and disadvantages of stocks, bonds, mutual funds, businesses, real estate, and insurance products as well as the different legal structures and when to use which product Most average investors know only of: . Bad debt, which is why they try and pay it off 2. Bad losses, which is why they think losing money is bad 3. Bad expenses, which is why they hate paying bills 4. Taxes they pay, which is why they say taxes are unfair 5. Job security and climbing the corporate ladder instead of owning the ladder 6. Investing from the outside, and buying shares of a company rather than selling shares of a company they own 7. Investing only in mutual funds, or picking only blue chip stocks The Definition of Rich Forbes magazine defines rich as $1 million in income and $10 million in net worth.
Rich dad had a tougher definition: a consistent $1 million in passive income, which is income that comes in regardless of if you work or not, and $5, 000, 000 in assets, not net worth. Net worth can be an elusive and much-manipulated figure. He also felt that if you could not maintain a 20% return from capital invested, you were not really an investor. The price to reach rich dad’s goal, starting from nothing, is actually measured in rich dad’s three E’s: education, experience, and excessive cash. “…Rich dad knew that the purpose of a business was to buy assets…essentially, the business buys assets with pre-tax dollars. “Rule Number One in becoming an Entrepreneur is to never take a job for money. Take a job only for the long-term skills you will learn. ” “…If you cannot sell, you cannot be an entrepreneur. ” “The biggest mistake people make is that they work too hard for their money…Most people do not get ahead financially because when they need more money, they take a part-time job. If they really want to get ahead, they need to keep their day job and start a part-time business. ” “The world is filled with great ideas for new products. The world is also filled with great products.
But the world is short of great businesspeople. The primary reason in starting a business part-time is not so much to make a product great. The real reason to start a part-time business is to make you a great businessperson. Great products are a dime a dozen. But great businesspeople are rare and rich. ” “The message is, therefore, do not bother trying to make a great product. FOCUS MORE ON STARTING A BUSINESS SO YOU CAN LEARN TO BECOME A GREAT BUSINESS OWNER. ” “Many people dream of starting their own business but never do because they’re afraid of failing.
Many other people dream of becoming rich but don’t become so because they lack the skills and experience. The business skill and experience is where money really comes from. ” “The education you receive in school is important, but the education you receive on the street is even better. ” The Entrepreneurial Spirit “…You build a business because of the challenge. You build a business because it is exciting, it’s challenging, and it will require all of you to make it successful. ” “There is no such thing as a successful poor entrepreneur or business owner.
You can be a successful and poor doctor, or a successful and poor accountant. But you cannot be a successful and poor business owner. There is only one kind of successful business owner, and that is a rich one. ” One of rich dad’s strongest criticisms of the educational system was: “In school, they train students to take tests on their own. If a child attempts to cooperate at test time, it is called ‘cheating. ’” Rich dad would also say, “In the real world of business, business owners cooperate at test time, and in the real world of business, every day is test time. ” If people want to become sophisticated investors and above, they must invest as a team. ” On rich dad’s team were his accountants, his attorneys, his brokers, his financial advisors, his insurance agents, and his bankers. I use the plurals here because he always had more than one advisor. When he made a decision, it was with input of the team. Today, I do the same. ” “Most small-business people dream of someday owning a boat or a plane. That is why they will never own that boat or plane. When I was first starting out, I dreamed of having my own team of accountants and attorneys, not a boat. ” …most people work hard and dream of getting away on their own boat. I first dreamed of having a team of full-time accountants and attorneys. That is why I can now have the big boat and the free time. It is a matter of priorities. ” “When people say, “Building a business is risky,” they often speak from a point of view of doing alone, a habit they learned from school. In my opinion, not building a business is risky. By not building a business, you are failing to gain a priceless real-world experience, and you are failing to get the best education in the world, the education that comes from your team of advisors.
As rich dad would say, “People who play it safe lose out on the best education in the world and they waste a lot of precious time. ” He would say, “Time is our most valuable asset, especially as First Step to Financial Freedom: “Take control of your financial statement. ” WHO READS FINANCIAL STATEMENTS o Business owners/managers of the business: an owner’s job description is to keep close tabs on his organization’s performance and to make changes in the allocation of company resources to maintain a high level of financial return. o Banks need financial statements to make judgments on whether to extend loans or lines of credit. Accountants require financial information to assess the health of an organization. o Investors and financial analysts need financial statements to determine the attractiveness of a particular organization when compared with a wide range of other investment opportunities. WHAT DO FINANCIAL STATEMENTS TELL YOU? In general, financial statements offer their readers the following important status information: o Liquidity: the company’s ability to quickly convert assets into cash to pay expenses such as payroll, vendor invoices, creditors, and so on. General financial condition: the long-term balance between debt and equity (the assets left after you deduct liabilities) o Owner’s equity: the periodic increases and decreases in the company’s net worth o Profitability: the ability of the company to earn profits (revenue that exceeds costs) consistently during an extended period of time o Performance: the organization’s performance against the financial plans developed by its management team or employees. • STANDING ORDER – instruction to a banker to make regular payments, or to a retailer for a regular supply of goods. PETTY CASH – money from or for small items of receipt or expenditure • EQUITY – value of the shares issued by a company; (in pl. ) stocks and shares not bearing fixed interest. • RETURN ON INVESTMENT • SECURITY – thing deposited as a guarantee of an undertaking or loan, to be forfeited in case of default. (often in pl. ) document as evidence of a loan, certificate of stock, bonds etc. • INTEREST RATE – price of a loan expressed as a percentage per year of the amount loaned. • COMPOUND INTEREST – interest payable on capital and its accumulate interest. INFLATION – the increase in prices over time that causes the purchasing power of money to decline. • ASSETS – a financial asset is something that puts money, or income, in your pocket. Assets include: cash, bank accounts, stocks, bonds, mutual funds, retirement funds, debts owed to you (or receivables), Net value of businesses you own, Net value of income-producing real estate you own. • STOCK – a) store of goods etc. ready for sale or distribution etc. b) capital of a business c) shares in this d) money lent to a government at fixed interest BONDS – commerce: certificates issued by a government or a company promising to repay borrowed money at a fixed rate of interest. • LIABILITY – debts etc. for which one is liable. • OVERDRAFT – 1) overdrawing of a bank account 2) amount by a which an account is overdrawn • CAPITAL – money etc. with which a company starts in business b) accumulate wealth c) capitalists collectively • CAPITALISM – economic and political system dependent on private capital and profit-making. • CAPITALIST – person investing or possessing capital 2) advocate of capitalism (of or favoring capitalism) • CAPITALIZE – 1) (foll.
By on) use to one’s advantage 2) convert into or provide with capital. • CAPITAL LEVY – tax on wealth or property. • CAPITAL SUM – lump sum, esp. payable to an insured person. • RETAIL – sale of goods in small quantities to the public, and usually not for resale. • ACCOUNT RECEIVABLE – represent the money that your clients and customers owe you for purchasing your products or services. When you allow a customer to buy your goods today and pay later, you’re creating a receivable. If you work strictly on a cash basis e. g. hot dogs stand, you don’t have any receivables, and this item will be zero. ACCOUNTS PAYABLE – these are the obligations owed to the many individuals and organizations that have provided goods and services to your company. Examples include money owed to your computer network consultant, your local utility company, and an out-of-house advertising agency that your marketing department uses for ad campaigns. • JOURNAL – a general file to temporarily hold transactions until you can classify them by transaction type. • LIQUIDITY – refers to the speed at which assets can be converted into cash. • MORTGAGE – a mortgage is a long-term real estate loan. INITIAL PUBLIC OFFERING (IPOs) • SECONDARY OFFERING • VALUE RECEIVED • VALUE GIVEN UP • BUSINESS PROPRIETOR • ENTREPRENEUR – • DEVALUATION • INTRINSIC VALUE • COMMODITY CURRENCY • GOLD STANDARD • FIAT CURRENCY • FAIR MARKET VALUE – the fair market value of business or a piece of real estate is the amount of money you could fairly expect to receive if you sold it. Note: you must deduct (and pay off) any money you owe on it, such as mortgage. • RENTAL REAL ESTATE • GOOD DEBT – this is debt that allows you to purchase assets. An example is money borrowed to purchase rental real estate.
The tenant’s payments are used to pay off the loan and generate cash flow. • BAD DEBT – money borrowed to purchase liabilities or luxuries. You cannot expect to get a financial return from something purchased with bad debt. • INCOME – money that goes into your pocket. Income sources are: Wages or salary, tips, interest on investments, Dividends, Rent from real estate, Royalties, Capital gains. • EARNED INCOME – taxed at a higher rate than other forms of income, this is the salary of wage you are paid by an employer for doing a job. Includes tips and self-employed wages.
Form of income that keeps many people on the left side of the CASHFLOW Quadrant. A young person who heeds advice to “get a good job” may end up stuck in the E quadrant. • PASSIVE INCOME – the least-taxed form of income. Passive income is money generated by a business or real estate property. Business or real estate owners aren’t actively involved in generating passive income; the money they have invested in assets is working for them. • PORTFOLIO INCOME – a type of passive income; it is income derived from a collection of paper assets such as dividends, stocks, bonds, mutual funds, or royalties from patents and license agreements.
It also includes interest earned from a savings account, an outstanding loan, or some other source. The difference between earned income and passive or portfolio income is this: if you have to show up for a job you have earned income; if you can sit back and let your assets work for you, you have passive or portfolio income. • PORTFOLIO – range of investments held by a person, company etc. • MUTUAL FUND – a portfolio of stocks that’s managed by a professional company. Investing in a mutual fund is a way to avoid the risk of picking individual stocks.
The fund manager’s strategy for selecting stocks depends on the goal of the mutual fund (growth, annuity) but, in general, the manager wants to spread the risk over a fairly large number of stocks so that a loss on any one stock does not significantly damage the return on the entire fund. • EXPENSES – An expense is the opposite of income; it is money leaving your pocket i. e. your total cash outflow, each month for instance. Expenses include: Taxes, Credit card payments, Home mortgage payments, Car loan payments, Utility payments, Grocery bills, Travel and entertainment, all other personal expenses.
Note: income pays expenses, and if you don’t have enough income you may have to incur additional debt to pay your expenses. • EXPENSES (2) – these include all resources used up or incurred by a business during a financial year irrespective of when they are paid for. They include salaries, wages, rates, rent, telephone, stationery, etc. • DOODAD – an unnecessary and sometimes unexpected expense or item you purchase that does not put money in your pocket. It may be a pleasure boat, a dream vacation, a new pair of sunglasses. Doodads can slowly and inexorably deplete your income – or serve as incentives to make more.
For example, if you’re determined to take a dream vacation but equally determined not to put it on your credit card, you may figure out a way to purchase a new asset that will generate the cash flow to pay for your holiday. After you pay for your vacation, you will still have the additional cash flow generated by the asset. People in the B quadrant learn the value of buying assets because it earns them the ability to pay for doodads. Certain personal expenses that relate to your business can become business expenses and thus tax deductions.
For instance, if you subscribe to an internet service and you use that service to communicate with clients, you can deduct that expense. Unlike personal expenses, business expenses are paid with pre-tax dollars. Of course, the expense must have a valid business purpose. • CAPITAL GAIN – profit from the sale of investments or property. • GROSS INCOME – the amount received before any deductions are made for taxes or other purposes. • NET INCOME – the actual amount of your paycheck after all deductions. • RECEIPT – the receipt of cash or cheques by the business, normally in return for goods or services rendered.
The receipt may relate to another financial period, e. g. it may be for goods sold at the end of the previous period. • PAYMENT – the payment of cash or cheques by the business in return for goods or services received. Again, a payment may be in respect of goods purchased in the previous financial year or a service to be rendered in the future, e. g. rates payable in advance. • CAPITAL RECEIPT – used to describe the amounts received from the sale of fixed assets or investments. • CAPITAL PAYMENT – relates to the amount paid for the purchase of a fixed (i. e. ong-term) asset. • REVENUE INCOME – the income which a business earns when it sells its goods. Revenue is recognized when the goods pass to the customer, NOT when the customer pays. • HIRE- PURCHASE – system of purchase by paying in instalments. • FIXED ASSET – comprise land and buildings, plant and machinery, motor vehicles, fixtures and fittings – in fact any assets which are to be used in the business for a reasonable period of time generally taken to be greater than one year. (Assets bought not for resale but for use in running the business e. g. buildings) CURRENT ASSET – consist of stock for resale, debtors, cash/bank. Current assets are short-term assets, not intended to be retained in the business for long. • CAPITAL EXPENDITURE – fixed assets help to create profit, and expenditure on them is what is known as CAPITAL EXPENDITURE. • REVENUE EXPENDITURE – relates to the day-to-day running of the business. Examples of revenue expenditure include expenses such as petrol for the delivery vans, telephone charges for the sales department, etc. • DEPOSIT – 1. Money in a bank account 2. Anything stored for safe keeping 3.
Payment made as a pledge for a contract or as an initial part payment for a thing bought 4. returnable sum paid on the hire of an item • DEPOSIT ACCOUNT – bank account that pays interest but is not usually immediately accessible. • PLEDGE – solemn promise; thing given as security against a debt etc. • COLLATERAL – security pledged as a guarantee for the repayment of a loan. • DISCOUNT – amount deducted from a full or normal price, esp. for prompt or advance payment 2. At a discount – below the usual price or value. • CREDITWORTHY – considered suitable to receive commercial credit. CREDIT – person’s financial standing, esp. as regards money in the bank 2. Entry in an account of a sum paid into it. • CREDITOR – a person to whom money is owed for goods. • DEBTOR – Person who owes the firm money • DEBIT – entry in an account recording a sum owed. • FORECLOSE (FORECLOSURE) – repossess the mortgaged property of (a person) when a loan is not duly repaid. • CARTEL – union of suppliers etc. to control prices. THE PURPOSE OF ACCOUNTING A business proprietor normally runs a business to make money. He or she needs information to know whether the business is doing well.
The following questions might be asked by the owner of a business: • How much profit or loss has the business made? • How much money do I owe? • Will I have sufficient funds to meet my commitments? The purpose of conventional business accounting is to provide the answers to such questions by presenting a summary of the transactions of the business in a standard form. FINANCIAL ACCOUNTING AND MANAGEMENT ACCOUNTING Accounting may be split into Financial Accounting and Management Accounting: a) Financial Accounting Financial Accounting comprises two stages: • Book-Keeping.
The recording of day-to-day business transactions; • Preparation of Accounts. The preparation of statements from the book-keeping records; these statements summarize the performance of the business – usually over the period of one year. b) Management Accounting Main Categories of Users of Financial Accounts • Equity Investors (shareholders, proprietors, buyers) • Loan Creditors (banks and other lenders) • Employees • Analysts and Advisers • Business Contacts (creditors and debtors, competitors) • The Government (the MRA) • The public • Management (Board of Directors)
Users can learn a lot about the running of a company from the examination of its accounts, but each category of user will have its own special perspective. Interests of Principal Users • MRA. Will use the accounts to determine the liability of the business for taxation. • Banks and other lending Institutes. These require to know if the business is likely to be able to repay loans and to pay the interest charged. But often the final accounts of a business do not tell the lender what he or she wishes to know. They may be several months old and so not show the up-to-date position.
Under these circumstances, the lender will ask for cash flow forecasts to show what is likely to happen in the business. This illustrates why accounting techniques have to be flexible and adaptable to meet user’s needs. • Creditors and Debtors. These will often keep a close eye on the financial information provided by companies with which they have direct contact through buying and selling, to ensure that their own businesses will not be adversely affected by the financial failure of another. An indicator of trouble in this area is often information withheld at the proper time, though required by law.
Usually, the longer the silence, the worse the problem becomes. • Board of Directors. The board of directors will want up-to-date, in-depth information so that it can draw up plans for the long term, the medium term and the short term, and compare results with its past decisions and forecasts. The board’s information will be much more detailed than that which is published. • Shareholders. These have invested money in the company and as such are the owners of the business. Normally, the company will be run by a team of managers and the shareholders require the managers to account for their “stewardship” of the business; i. . the use they have made of the shareholder’s funds. • Employees. Employees of the company look for, among other things, security of employment. • Prospective Buyer. A prospective buyer of a business will want to see such information as will satisfy him or her that the asking price is a good investment. ACCOUNTING PERIODS • An owner of a business will require financial information at regular intervals. He or she will want to be able to check periodically how well or badly the business is doing. • Financial accounts normally prepared on an annual basis, e. g. twelve months to the 31 march. Preparing accounts on an annual basis facilitates comparisons between one year and previous years and assists forecasting the next year. In this way, true comparison of profit/loss can be gained. • Accounts normally have to be prepared annually for tax purposes as tax is assessed on profits of a 12-month accounting period. • In the case of limited companies, accounts are prepared annually to the “accounting reference date”. It is necessary to calculate annually the amount of profit available for distribution to shareholders by way of dividend. THE FUNDAMENTAL CONCEPTS OF ACCOUNTING
Statement of Standard Accounting Practice No. 2 is called Disclosure of Accounting Policies. It identifies four fundamental accounting concepts which should be followed in preparing accounts. These four concepts are also included in company law so companies must follow them in preparing published accounts. These concepts are known as the accruals, prudence, going concern and consistency concepts. ACCRUALS Accruals is taking into account or matching income and expenditure occurring within an accounting period, whether actual cash is received or paid during the time or not.
The reasoning behind concept is that profit for the period should represent fairly the earnings of the time covered and, in view of the dynamic nature of any business; it is unlikely that all invoices will have been paid. However, they should be accounted for to give a true picture. A distinction is made between the receipt of cash and the right to receive cash, and between the payment of cash and the legal obligation to pay cash. The accruals concept requires the accountant to include as expenses or income those sums which are due and payable. PRUDENCE
Prudence is proper caution in measuring profit and income. Where sales are made for cash, profit and income can be accounted for in full. Where sales are made on a credit basis, however, the question of the certainty of profits or incomes arises. If there is not a good chance of receiving money in full, no sales are made on credit anyway; but if, in the interval between the sale and the receipt of cash, it becomes doubtful that the cash will be received, prudence dictates that a full provision for the sum outstanding should be made. A provision being an amount which is set aside via the profit and loss ccount. The two main aspects of this concept are that: • Income should not be anticipated and all possible losses should be provided for. • The method of valuation of an asset which gives the lesser value should always be chosen. Prudence is often exercised subjectively on grounds of experience and is likely, in general, to lead to an understatement of profit. The subjectivity involved can lead to variation between accountants in the amount of provision for bad debts, etc. and is bound to create differences between results obtained by the same general method of measurement.
In long-term credit arrangements, e. g. hire-purchase agreements, difficulties arise in the actual realization of income and profit. GOING CONCERN BALANCE SHEETS AND INCOME STATEMENTS “People who are not aware of the power of a financial statement often have the least money and the biggest financial problems. ” There are many different types of statements reflecting the state of your finances. The two most important are the balance sheet and the income statement. Understanding these two documents and their relationship to each other is the master key to financial freedom.
THE BALANCE SHEET This balances the value of your assets against the value of your liabilities. One half of the balance sheet lists assets, the other half liabilities and your net worth: DIPLOMA IN BUSINESS ADMINISTRATION – PART 1 Accounting Syllabus Aims: 1. To demonstrate an understanding of the theoretical framework of accounting and the principles underlying accounting statements. 2. To demonstrate an understanding of the application of accounting systems using information technology. 3. To be able to prepare and present limited company financial statements. . To evaluate the performance and financial position of organizations from their financial statements. THE B (BUSINESS OWNER) Unlike the perfectionist S, the B type loves to delegate work. The motto of a true B is, “Why do it myself when I can hire someone better to do it for me? ” The true B can leave his or her business for over a year and return to find it more profitable than before. That’s not usually the case with someone in the S quadrant. When an S leaves his or her business for over a year, chances are there is no business to return to.
Being a successful B requires technical business skills. B’s motto is O-P-M (Other People’s Money) and O-P-T (Other People’s Time). B’s understand the concept of leverage. To succeed, B’s need to know more than just how to build superior products or services – they need to know how to build the solid network of business systems without which their offering won’t sell. And they have to be skilled in the art of leadership. Successful B’s bring out the best in their people so that their people will carefully tend the network of business systems. “Many people have great ideas but very few have fortunes.
To be a successful B, you have to do more than just have a great idea – you have to understand business systems. ” “If you want to be rich, you need to be financially literate. ” “The poor and the middle class turn cash into trash, or liabilities. Meanwhile, the upper class buys things like stocks, real estate, and businesses, turning cash into assets. ” CORPORATION A corporation is really nothing more than a way of doing business. It is a legal entity regarded as separate from the owner, one that offers distinct tax advantages as well as liability protection from creditors and others who might sue.
The owner controls the corporation and is a shareholder, possibly the only shareholder. As owner and shareholder, the owner is the boss. The owner controls what happens in the corporation, but because the corporation is a separate entity, the owner doesn’t own any of the corporation’s assets and therefore doesn’t have to assume any of the corporation’s debts. The corporation owns its own assets and pays its own debts. This is one of the secrets of the rich: Own nothing, but control everything. After the C corporation deducts business expenses from its income, tax is paid on the corporation’s profits.
The owner/shareholder in turn pays tax on any money received from the corporation, usually in the form of a salary or bonus, and the corporation can deduct these payments as expenses on its tax return. However, when a C corporation pays a dividend to its shareholders, the dividends are taxable to the shareholders but not deductible by the corporation. When the C corporation deducts legitimate business expenses and pays out profits in the form of compensation to its shareholders, there may be no taxable income left. In that case, the corporation doesn’t have enough income left to pay dividends.
THE SECRET OF THE RICH This secret has been around ever since the days of sailing ships, when the rich created the corporation as a vehicle to limit their risk. The rich would put their money into a corporation to finance a voyage. If the ship was lost the crew lost their lives, but the loss to the rich would be limited to the money they invested for that particular voyage. Corporations can protect assets and serve as vehicles for the creation of new assets. If you understand that basic secret, then you’re ready to master the art of building the B-I triangle. There are many people with great ideas but few people with great fortunes. The B-I triangle has the power to turn ordinary ideas into great fortunes. ” THE BUSINESS-INVESTOR TRIANGLE Anyone can start a company, yet how many can start a company that survives and thrives? Anyone can purchase real estate, yet how many know how to analyze a property or how to structure the purchase to take advantage of the tax savings available for real estate? The key to business success in either business development or real estate lies in the so-called business-investor triangle, or B-I triangle. 88.
The Law of Clarity: The clearer you are about your goals and objectives, the more efficient and effective you will be in achieving them. Do You Really Need an MBA? For many years, people have gone back to school to get an MBA (Masters of Business Administration) because it’s the “thing to do. ” Companies want to see the degree on your resume, making the degree the fastest track to corporate executive positions and bigger paychecks. This has been the case for some time, and truth be told, this is still the case. Consider the statistics garnered from research with recruiters worldwide: ? Demand for MBAs is rising at about 20 percent per year. Demand for MBA/consultants is up about 35 percent. ? Salaries are on the rise, with the average new MBA graduate starting at $84,500; in some areas, the salary is well over $100,000. But money is just one reason why you may want to seek an MBA. Here are some equally (if not more) important reasons: ? To develop skills in business functions: economics, finance, marketing, management, operations, and accounting. ? To acquire valuable soft skills: leadership, teamwork, ethics, and communication. ? To develop an entrepreneurial mindset: you want to become innovative and opportunistic to tackle the challenges of a dynamic, global world.
Exploring the New World of Business Due to the nature of competition – where only the fittest companies are destined to survive – businesses are always pushing the envelope of creativity, innovation, and technology. They’re constantly testing new approaches, new procedures, new processes, and new ways of doing business – looking for a little (or large) advantage over their competitors. These are exciting times in business, as evidenced by the following: ? The Internet has leveled the playing field for small companies.
They can now look and act as multinational corporations and reach millions of customers without the burden of physical assets such as plants and equipment. ? New business models, communication technologies, and distribution methods enable businesses to take their products and services anywhere they want. ? Successful entrepreneurs such as Bill Gates and Warren Buffet continue to demonstrate to the rest of the business world what it means to be philanthropic. ? A new generation of workers – the New Millenials – are changing management styles and corporate culture as they force baby-boomer bosses to consider a new definition of work ethic. The business world can watch in amazement as China grows at light speed. It will become the biggest economic power in the world in the not-too-distant future. ? Everyone with a computer and an Internet connection has access to the same information (“Just Google it! ” has become a popular search engine phrase). Because of YouTube, for instance, everyone can have their 15 minutes of fame on the Internet. Rich Dad’s Guide To Investing Investments of the Rich “…I was most intrigued by the idea that there were investments only for the rich, and then there were investments for everyone else.
I remembered that when I was a kid working for rich dad, all he talked about was building his businesses. But now that he was rich, all he talked about was his investments…investments for the rich. ” “The only reason I built businesses was so I could invest in the investments of the rich. The only reason you build a business is so that your business can buy your assets. Without my businesses, I could not afford to invest in the investments of the rich. ” Rich dad went on to stress the difference between an employee buying an investment and a business buying an investment.
He said, “Most investments are too expensive when you purchase them as an employee. But they are much more affordable if my business buys them for me. ” “Learn to build businesses and invest through your businesses. ” “When I spent time with my rich dad, I began to realize that he saw a completely different world. He could see a world of too much money. That view was reflected when he said, “Don’t worry about money. If we do the right things, there will always be plenty of money,” or “Don’t let not having money be an excuse for not getting what you want. ” “The trouble with being young is that you don’t know what it feels like to be old.
If you knew what being old felt like, you would plan your financial life differently. ” “It is important to plan as early in life as possible. ” “Words form thoughts, thoughts form realities, and realities become life. The primary difference between a rich persons and a poor person is the words he or she uses. If you want to change a person’s external reality, you need to first change that person’s internal reality. That is done through changing, improving, or updating the words he or she uses. If you want to change people’s lives, first change their words. And the good news is, words are free. Investing is a plan, often a dull, boring, and almost mechanical process of getting rich…it is simply a plan, made up of formulas and strategies, a system for getting rich…almost guaranteed (almost because there is always risk involved). “I now realize why it is so hard for most people to follow a simple plan…Because following a simple plan to become rich is boring…Human beings are quickly bored and want to find something more exciting and amusing. That is why only three out of a hundred people become rich. They start following a plan, and soon they are bored.
So they stop following the plan and then they look for a magic way to get rich quick. They repeat the process of boredom, amusement, and boredom again for the rest of their lives. That is why they do not get rich. They cannot stand the boredom following a simple, uncomplicated plan to get rich. People think there is some magic to getting rich through investing. Or they think that if it is not complicated, it cannot be a good plan. Trust me; when it comes to investing, simple is better than complex. ” BASIC RULE NUMBER ONE Investment basic rule number one is to always know what kind of income you are working for.
There are 3 different kinds of income: 1. Earned Income: income generally derived from a job or some form of labor. In its common form, it is income from a paycheck. It is also the highest-taxed income, so it is the hardest income with which to build wealth. When you say to a child, “Get a good job,” you are advising the child to work for earned income. 2. Portfolio Income: income generally derived from paper assets such as stocks, bonds, mutual funds etc. Portfolio income is by far the most popular form of investment income, simply because paper assets are so much easier to manage and maintain than any others. . Passive Income: income generally derived from real estate. It can also be income derived from royalties from patents or license agreements. Yet approximately 80% of the time, passive income is from real estate. There are many tax advantages available to real estate. BASIC RULE NUMBER TWO Investment basic rule number two is to convert earned income into PORTFOLIO INCOME or PASSIVE INCOME as efficiently as possible. BASIC RULE NUMBER THREE Investment basic rule number three is to keep your earned income secure by purchasing a security you hope converts your earned income into passive income or portfolio income.
SECURITY – A security is something you hope will keep your money secure. And generally, these securities are bound up tight by government regulations. BASIC RULE NUMBER FOUR It is the investor that is really the asset or the liability. BASIC RULE NUMBER SIX If you are prepared, which means you have EDUCATION and EXPERIENCE, and you find a good deal, the money will find you or you will find the money. Good deals seem to bring out the greed in people. And I don’t mean to use the word greed in a negative way. I speak of greed as a general human emotion, an emotion we all have.
So when a person finds a good deal, the deal attracts the cash. If the deal is bad, then it is really hard to raise the cash. WHAT IS TO “REFINANCE”? To finance something means to take a loan to buy something. The loan amount is almost always less than the total value of that thing. To refinance means to take a different loan on that same thing. The refinance process always makes sure that the original lender is paid first, and the borrower gets or pays the difference. Example: 1) I borrow $80 to buy a $100 home from Lender X. Five years later: ) The house value increases to $125 (and I still owe $75 to lender X from step one) 3) I refinance by borrowing $100 because my home value has increase, but I don’t get all $100. $75 goes to Lender X, and I get $25 (and now I owe more money) This is also called “pulling out equity”… I’ve pulled out $25 of equity from my home, but this is problematic if home values have peaked, and shortly after experience a drop in value. If six moths later, my home value drops to $95, then I’m “under water” because my house is then worth less than what I owe on it: $100. That’s what a lot of people are facing now.