Business : A Dummy’s Guide to P&L
Hello, to all folks reading this. Many of my friends, I realised, do not know the very basics of how a simple business and investing works. Many a times on a call (whilst working on a FinTech idea during start-up studio at ), I realised I was explaining very fundamental concepts such as “Assets”, “Liabilities”, “P&L” etc to my friends while explaining the start-up idea.
Lo and behold, here I am, taking this opportunity to make a dummy’s guide to how business works in simple terms. This is Post #1 in this series. So here we go.
I am going to make this short and hopefully , palatable - for the newbies.
Let’s open a business together. Jane wants to open a Tea/Coffee Stand.
Begin — Form a corporation: A filing with the state, it is a legal entity separate and unique from the the individuals who invest in it. Let’s call our business the “Jane’s Tea Stand”.
We start our business with a 1000 shares of stock.
Next, we are going to sell the extra 500 shares for a $1 to an investor. The investor will put $500 and we put the idea. So the investor currently owns a third of the business for the $500.
We own 2/3rds of the company with a $1000.
So the business is currently worth $1,500 at the start.
Jane — $1000 (67%)
Investor — $500 (33%)
____________________
Total= $1500 (100%)
We are going to need more than $500 of course! So, Jane tries her luck with one of the three F’s : Friends, Family and Fools.
Lucky for us, our friend, let’s call him, Patrick decides to lend Jane $250. Yay! and then, Jane agrees to pay 10 % interest a year.
A novice question — Why should Jane raise such debt and not sell more stock?
Answer: Jane wants to keep a major portion/stock of the company so that when the business succeeds and “profits”, she eats the bigger pie.
Balance Sheet 101
A balance sheet like above, tells you where a company stands, what the assets are, what the liabilities are, what the net worth of a company or shareholder’s equity is.
Let’s take assets: In Jane’s case she raised $500 and we also have “goodwill” which is $1000.
Assets are deemed as the property owned by a company, which provide value.
In exchange for the $500 the investor got a thirds of the share and the two-thirds is owned by Jane.
Jane owes $250 debt for borrowing from Patrick. This is a “liability”. In the simplest terms, “liabilities” are whatever is owed — debts, salaries, expenses etc.
Capturing the Essence
Jane has $500 by selling stock
Jane has $250 by raising debt — so, owes $250 in loan.
As a Corporation, the shareholders’ equity is $1500 (as seen in the chart).
That’s all for today.
In the next post in this series, I will talk about fixed assets and inventory.