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What is it and Why May it be Important?
A financial statement gives an accurate and current snapshot of your finances and investments. It let's you know where you are so that you can plan well for where you want to be. Financial statements allow a person to invest in both real estate and businesses knowing exactly what you are getting into by understanding the numbers.
I'm including an example financial statement I created that is based on Robert Kiyosaki's teachings on these because I find it simple for teaching new investors how to begin looking at cash flow.
I'm including an example financial statement I created that is based on Robert Kiyosaki's teachings on these because I find it simple for teaching new investors how to begin looking at cash flow.
I realize this may be difficult to see, especially if you are attempting to read this post on a phone, but I simply want to give you a general idea at this point.
When investors talk to me about risk I immediately refer to financial statements because they give such a clear picture of risk vs. strength of an individual investment or business as well as a person's overall financial picture.
When investors talk to me about risk I immediately refer to financial statements because they give such a clear picture of risk vs. strength of an individual investment or business as well as a person's overall financial picture.
How do I Learn How to Use it?
As you can see above, there are two major parts of the financial statement. The first is called an income statement and shows your income as well as your expenses (again, you can use this for investments/businesses as well as your personal financial picture). Below the income statement is a balance sheet which shows your assets as well as your liabilities. Both of these are extremely important to understand.
Before going forward I want to quickly recommend that each and every person reading this post talks to you accountant about financial statements so that you have a professional opinion on this. I'm giving some very simple basics in order to start you off, but if you really want to move forward with this you will want to speak with an accountant. The problem with some accountants is that they may not understand the difference between a liability and an asset, so I'll go over these two concepts quickly right now
An asset, and my definition will be different than other people in your life at some points, is anything that puts money in your bank account. A liability is anything that takes money out of your account. I'll provide a few examples:
-Your home is not an asset, it is a liability because it costs money each and every month. Even when the mortgage is paid off it is still a liability because you are paying property taxes, maintenance, insurance, and utilities to keep the thing. Yes, your home can have equity in it, but that doesn't mean it is an asset. You bank will disagree with this definition. They will call it an asset. One reason, in my opinion they call your house an asset is because while you have a mortgage on the house it is an asset to the bank (it puts money into the bank's accounts each and every month)
-If you write a book and collect royalties for the rest of your life... the contract and book are assets.
-If you own a property that cash flows after ALL EXPENSES are accounted for it is an asset (please read my previous post on this for a definition of expenses. This will at least provide a brief explanation to get you started)
-If you own a property that you must manage yourself in order to make it cash flow... it is an incredibly sketchy asset. Why? Because as soon as you can't mange the place for a month it can instantly turn into a liability. If you get into an accident or die and your family doesn't know how to properly manage a property, it has become a liability for your family. Most "investors" in real estate do not own assets. They own liabilities.
-If you loan money to a family member with a contract that states they will pay you back the loan with interest on a monthly basis... this loan to them is an asset.
Before going forward I want to quickly recommend that each and every person reading this post talks to you accountant about financial statements so that you have a professional opinion on this. I'm giving some very simple basics in order to start you off, but if you really want to move forward with this you will want to speak with an accountant. The problem with some accountants is that they may not understand the difference between a liability and an asset, so I'll go over these two concepts quickly right now
What is an Asset?
An asset, and my definition will be different than other people in your life at some points, is anything that puts money in your bank account. A liability is anything that takes money out of your account. I'll provide a few examples:
-Your home is not an asset, it is a liability because it costs money each and every month. Even when the mortgage is paid off it is still a liability because you are paying property taxes, maintenance, insurance, and utilities to keep the thing. Yes, your home can have equity in it, but that doesn't mean it is an asset. You bank will disagree with this definition. They will call it an asset. One reason, in my opinion they call your house an asset is because while you have a mortgage on the house it is an asset to the bank (it puts money into the bank's accounts each and every month)
-If you write a book and collect royalties for the rest of your life... the contract and book are assets.
-If you own a property that cash flows after ALL EXPENSES are accounted for it is an asset (please read my previous post on this for a definition of expenses. This will at least provide a brief explanation to get you started)
-If you own a property that you must manage yourself in order to make it cash flow... it is an incredibly sketchy asset. Why? Because as soon as you can't mange the place for a month it can instantly turn into a liability. If you get into an accident or die and your family doesn't know how to properly manage a property, it has become a liability for your family. Most "investors" in real estate do not own assets. They own liabilities.
-If you loan money to a family member with a contract that states they will pay you back the loan with interest on a monthly basis... this loan to them is an asset.
How do I Learn about Risk from a Financial Statement?
I will explain this very quickly using a few examples. You can judge who is taking bigger risks. Person A owns 5 rental properties (assets) that all cash flow and she has a full time job that pays $50,000 each year which is enough to get by on year to year. Person B has no assets, but has a job that pays her $200,000 each year and a pension that states it will pay her $60,000 each year until she dies in her retirement. Who has taken care of their risk of not having money in retirement better?
Person C invests in a single family home. It cash flows at $1,000 each month and the outstanding mortgage is $200,000. Person D invests in a multi-family property that has 10 units with each unit cash flowing at just $50 each month and an outstanding mortgage of
Hint: Evaluate these scenarios by plugging information into a financial statement to see how things change. As a general rule, the more assets a person has and the more sources of income (income streams) a person has, the less risk that person is taking. Why? Because if one income stream disappears for any reason, there are others to rely on. If there is only one income stream it doesn't matter how big it is, if it disappears, there is no income left. Also, no matter how big debt looks, if it is consistently paid off the risk of this debt is mitigated. If a property has multiple income streams, it has less risk because if one income stream dries up, there are others that will still balance the books.
Summary
Financial statements are not extremely difficult to understand, but they will take some practice and potentially some help from someone who knows more about them than you do in order to make sure you are taking everything into account. Having said this, they are extremely valuable tools for evaluating your financial picture or an individual investment. If you don't understand the basics of financial statements I would recommend you don't invest in anything because you are taking on a lot of risk no matter what you invest in without understanding the risk. Overall what I recommend is that you being to understand financial statements and then begin investing for your future!
Here's to your future of risk-averse investing!
If you would like to learn more about investing in real estate please
contact me at the email address listed at the beginning of this article
or go to my website at: www.akerahomes.com/investing-in-real-estate.html
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