Introduction to Balance Sheets | Housing | Finance & Capital Markets | Khan Academy

Welcome. Well there’s been a lot of news
lately about what’s going on with Bear Stearns and
Carlisle Capital. And I go to these parties, and
I start explaining to people because it’s very exciting. It’s actually very important,
to all of our collective futures and the whole health of
the financial system, and I feel like people’s eyes
start to glaze over. So with that in mind, I decided
to take a little bit of a hiatus from the core math
and physics videos, and actually do some accounting
and finance videos. Because I think what’s happening
in the world right now is extremely important. And I’m not just going to go
straight into what’s going into Carlisle and Thornburg and
all of these characters. Because I think the newspapers
do that, but a lot of people don’t understand the
basic accounting. What is a write-down, what does
it mean when you don’t have liquidity, in really
tangible ways. So I’m going to use the same
Khan Academy techniques to hopefully explain
some of this. So I’m going to start with just
a very basic accounting concept of the balance sheet. You might have a sense
of what it is. So let’s say a scenario. Let’s say I want
to buy a house. So this is, let me
draw a house. So let’s say this is the
house I want to buy. And the owner of this house
is asking for $1 million for this house. And I like the house, and I
think that’s a fair price. Other houses in the neighborhood
also went for $1 million, whatever. Maybe they went for more,
so I think it’s actually a good deal. But all I have in my pocket is,
let’s say I have $250,000. So what I’m going to do is, I’m
going to create my balance sheet before I do anything. Before I go to try
to get the house. What is my before-house
balance sheet? What are my assets? I’m going to write
down Assets. Well before we know what my
assets are, let me tell you what an asset is. An asset is something that’s
going to give you some future economic benefit. So for example, cash
is an asset. Why is cash an asset? Because in the future you can
use that cash to get stuff from people, or make them
do things, or buy stuff. You can, in a month from now,
you can use your cash. And you can make someone
dance for you. Or you can buy a car, or
you can go on vacation. So there’s all sorts of
things you can do. I don’t know if someone dancing
for you is an actual economic benefit, but
you get the idea. So cash could be an asset. A house could be an asset,
because the economic benefit you get in the future is, you
get to live in it, and not freeze when it’s freezing
outside. So that’s what an asset is. So what are my assets, before
I buy the house, or get a loan, or all of the things
that are about to happen? Well I have cash, I have
$250,000 worth of cash. What are my liabilities? I’m going to write the
liabilities on the left-hand side. I think that’s the convention,
but I forget. It doesn’t matter. What are my liabilities? Well, a liability is something
that’s an economic obligation to someone else. So if I take a loan from
someone, I owe them interest, or I have to pay them back
the actual value of the loan one day. Say I have an IOU where I
promise to dance for someone in the future. That could be a liability. It’d be hard to value, but
that’s something that I have to do in the future. But what are my liabilities
here? Well in the example I gave, I’m
just Sal, I have no debt, I paid off my college
loans, everything. And I have $250,000 in cash. So what are my liabilities
before I buy the house? Well, nothing. I don’t have any liabilities. I don’t owe anybody anything. And that’s, actually,
that to me is the definition of freedom. So I have zero liability. So what is my equity? And you’ve probably heard this
word, people borrowing their equity, and all of
these things. So I’m going to give you a
little equation, actually, just to take a little
bit of a tangent. That assets, A for assets,
is equal to liabilities plus equity. So in this case, our assets
are $250,000. My liabilities are what? I owe nothing to nobody. I don’t know if that was
correct, but anyway. I owe nothing to anyone. So my liabilities are zero. So my equity must be $250,000. So in this case, if I made a
balance sheet before I enter into any transactions — let me
make it look a little bit like a balance sheet. My assets are $250,000. I have no liabilities. And then my equity would
be $250,000. And if I were to draw this
graphically– actually, I should probably draw
it like this. I have no liabilities. So let me draw another little
mini balance sheet here. That’s a neat square. You probably can’t
see that square. So I put my assets on
the right-hand side. And I’ll say, there, I have
$250,000 of cash. And on the left-hand side,
I have no liabilities. And I’ll just say I have equity,
I have $250,000. Now, equity might not make a lot
of sense to you right now, because I’m just saying, well,
my equity is equal to my cash. in general, equity is
just what you own. After all of your assets and
liabilities are kind of resolved, or they’re
cleared up, what do you have left over? That’s equity. So in this situation, after I
pay off all of my debts, what do I have left over? Well I have no debts, so I have
$250,000 in cash, total. This will start to make sense
when I go to the bank now to get a loan to buy this house. So this house is a $1 million
house, right? So how much of a
loan do I need? Well, I have $250,000 cash, so
I’ll go to the bank for a loan for the remainder,
for $750,000. So let me draw the bank. This is the bank. The big dollar sign is made out
of granite, to show you that it can never fail. It’s going to be there forever,
even if they do silly things, like– well I won’t go
into all the silly things that they do, but they do
many silly things. We’ll go into that later. But the bank is going to give
me another $750,000 in cash. And in return, I’m giving
them essentially an IOU. And I’m going to pay interest.
So they’re going to hold this little security that says,
Sal owes me $750,000. And he has to give me 10%
interest every year. So $75,000 a year, or
something like that. And in return I get
$750,000 in cash. So what does my balance
sheet look like now? Well, let me draw it. Let me make sure my balance
sheet now looks, let me draw it like a square, because
I think the visual representation is helpful,
and then I will split it. So what are all my assets now? I had $250,000 and
I got another $750,000 from the bank. So now, what are my assets? Well, $250,000 plus $750,000. I now have cash of $1 million. What are my liabilities? Well, my liability, that’s
something that I owe to someone else. I owe the bank $750,000. So liabilities, I’ll just say L,
L for liabilities, because I’m running out of space. My wife was complaining that I
make these things very hard to read, but what can I do. Anyway. So my liabilities– I owe
the bank $750,000. So that’s a liability. And then the equity is,
essentially– we would look at this formula. Assets equal liabilities
plus equity. This is $1 million,
this is $750,000. What do I have left over? Well, I have $250,000
left over. That’s my equity. And I think hopefully the
concept of equity is starting to make a little more sense. Now we have– I could say that
I have $1 million, and some people are like that. They think they’re millionaires
when they have $1 million in assets. But they don’t consider, well
they might have $1 million of assets, but they might owe
other people $900,000. So I wouldn’t consider that
person a millionaire. They’re more of a hundred
thousand-aire. Your assets might be $1 million,
but you’re not nearly a millionaire, because
you still owe other people $750,000. What you have left over, that
really is your net worth, or what you can have claim to. And that’s your equity. Sometimes it’s called
owners’ equity. Or if there was a bunch of
people pitching together, it would be called shareholders’
equity. And maybe I’ll do a little bit
more on that in the future. But hopefully now you can see
that the balance sheet is starting to seem a little
bit useful. I have the cash, and I took the
loan from the bank, but now I still haven’t bought
the house yet. So what am I going to do? Well I’m going to give my cash
to the old owner of the house. Or maybe this Toll Brothers,
they just built this McMansion for me. So I give them $1 million, and
in return they give me the deed to the house. I could just say they
give me the house. The house is always there, but
you know it’s really just a contract and all the legal
structure that I get around it, and all the property
rights and all of that. But that’s getting too
philosophical. So now what does my balance
sheet look like? Instead of cash– I think I’m
running out of space and time to draw another balance sheet–
I don’t have cash worth $1 million. I now have a house
worth $1 million. Assuming that it really is worth
it, and that was the correct price, I didn’t
overpay, whatever. I now have, my assets are
a $1 million house. And I owe the bank $750,000. So what’s left over for me
is $250,000 of equity. I’m about to run out of time. So I’m going to leave
you from this video. In the next video, I’m going
to start explaining what happens if the value of the
house goes up or down, or you need cash, and all of these
interesting things. And we’ll start to learn a
little bit more about what’s going on in the world. See you soon.

100 thoughts on “Introduction to Balance Sheets | Housing | Finance & Capital Markets | Khan Academy

  1. Very late reply I know – sorry for digging this up! But wouldn't a house be considered premises or a fixed asset? I know it doesn't generate income but it's fixed and it does have a value even if you are paying bills and stuff. That's they way I've been doing it anyway!

  2. Its considered equity because if the asset were to be liquidated that particular value would be left over after all liabilities are settled (I think).

  3. In the traditional definitions of accounting anything you buy can be considered an asset because it has a value attached to it at the particular moment that you buy it.

    I'm assuming that you're using some professional's opinion on what an asset is (ex. Robert Kiyosaki)

  4. Liquid assets are assets that are easily converted to cash. Liquid assets include: stocks, bonds, other marketable securities, and of course cash.

    Liquidity is the simply the sum of all your liquid assets.

    Hope this helps

  5. These videos are great. I already knew all about assets and liabilities but didn't know anything about equity, but now, thanks to the Khan academy, I know what equity is.

  6. absolutely right. when you do penny stock trading get good suggestions from professionals is the wise idea. just listen for now, even my mom started making descent money from penny stocks trading using a professional service. have a try and make the most of them 🙂 –>

  7. Being able to read and interpret a balance sheet is one of the most crucial elements that anyone in business should be able to do.

    i love using this videos as complements to my college courses!

  9. Khan Academy got me through grade 12 bio and im SOOO EXCITED that you have videos to help get me through accounting!! thanks so much for all you do!!

  10. Man this guy is funny as hell…great videos, Im gonna take some of his finance advice and lapdance my debts away jajajaja.

  11. my high schoool teacher should die, he teach me like climbing mount everest!!!! thanks man now i get it 1000000%

  12. Where I'm from, assets go on the left-hand side of the balance sheet. Whereas, the liabilities and equity go on the right.

    Furthermore, the 'assets = liabilities + equity' formula is somewhat misleading. I say this, because, in order to utilise such a formula, you have to calculate the equity. And, equity is the last thing to calculate in a balance sheet.

    I was taught: equity = assets – liabilities. This way, it indicates what order you should complete the balance sheet in. In other words, calculate and add assets (or its monetary values) together. Then, calculate and add liabilities (or its monetary values) together. THEN, take the liabilities away from the assets, which will leave you with the equity.

  13. How do you know everything? One minute your teaching me about cellular respiration the next minute its finance. What went wrong with my childhood?

  14. You're an awesome man Khan!
    Thank you so much for helping us all!
    Incredibly useful, and certainly life changing information!

  15. "use cash to make someone do something for you" right there i thought of strippers
    …and then he said make someone dance for you XD

  16. In most example balance sheets, I see equity is same as asset. In some cases, the equity is not the same as assets, but is the result of asset-liabilities?

  17. anyone come from reading Rich Dad Poor Dad? I keep hearing Robert Kiyosaki's protests when ever Khan says the house is an asset haha.

  18. You took a loan of 750k from the bank, you had 250k in your hand. Total becomes 1000k which you pay to but the house for 1M. So, after buying the house, how do you have an equity of 250k? Just curious.

  19. waste video i can catch his class how speed is he teaching

    do not upioad like this
    we are not in england we are in india
    waste fellow who selected him

  20. Surely your liability needs to include the interest you owe? Or does you represent that by increasing the liability as time passes?

  21. Although a lot of explanations start with Assets, I think the easiest term to begin with is Equity.

    Think of Equity as [stuff (you own) that you haven't borrowed].

    Liabilities are [stuff you have borrowed].

    Assets, then, is an artificial term standing for [stuff (you own) that you haven't borrowed] + [stuff you have borrowed].

    Assets = [stuff you have borrowed] + [stuff (you own) that you haven't borrowed]

    A = L + E
    but some people might think that it is more intuitive to start with Assets and write:

    A – L = E

    And from this equation one can easily derive:

    A = L + E

    But the first explanation helps me understand better what Assets really are. Although, in the end it's all the same.

  22. Sir ur lecture design very beautifull.lecture deliver of balance sheet through examples sre awsums.
    I got it everything

  23. I hope the students of today realize how lucky they are. When I finished my Accounting degree there wasn't such thing as Youtube and no such thing as ebooks that you can get at a blink of the eye. If the teacher was not so good teaching a subject, things could get really hard. You would need to hurry up to get a library book before everybody else. Also, usually students would gather to study together and if you were lucky, one guy that would know more about one given subject would try to explain to the rest of us and maybe we would take copies of his/her documents. Today, you just search the internet and usually everybody can find a lot of free information about almost any given subject.

  24. excellent explanation by Salman. Also watch This 101 video which will help you understand accounting

  25. wait, what do you do with the interest on the bank loan wouldn't you have to subtract it from your $250,000 or add it to the $750,000 or something??

  26. As you go through the finance playlist, you can hear bits of the financial crisis unravel. Very interesting to hear it from the teacher as we learn about finance ^^

  27. I like your teaching style. So effective. You have really helped me in my studies in almost all my courses.

  28. Sounds like me…talking about the economy at parties lol. Your videos have taught me the basis of the financial system and are quenching my thirst for the understanding that I've had before I discovered your tutorials. Thank you and have a blessed New Year.

  29. I really love your videos…. except for one little thing…. the jittery mouse…. I must be like a cat lol …. cant stop watching the mouse and then I get dizzy. Calm down please lol

  30. A house is not an asset – Robert T. Kiyosaki
    If you need to pay down that house its NOT an asset. An asset is something that puts pocket in your money. After you bought the house, you have no assets. After you pay down the house you have an asset.

  31. Hi Mr. Khan! Just wanted to thank you for helping me ace my education in business admin and economics. Couldn't have done it without you!

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