Overview of Balance Sheet and Statement of Cash Flows

When we were last with our SayAhh cofounders, they had implemented an accounting system and Jane had contributed $50,000 for a 55/45% equity split. This week we introduce two of SayAhh’s key accounting documents: the Balance Sheet (BS) and Statement of Cash Flows (SCF) showing how this investment is accounted for.

The investments by the founders created two transactions. Since SayAhh is a C corporation that is incorporated in Delaware, they decided to have a very low non-zero par value for their shares, set at $0.00001, to prevent higher franchise stock taxes. Thus for the 10M shares issued to the them, Jane invests $55 and Dick invests $45. Jane also invests $50,000 as previously agreed. These deposits increase the checking account balance and also the equity accounts, and results in a solvent company and a decent starting bank balance.

Below is the Balance Sheet as of 8/21/11. Fred Wilson’s MBA Mondays series shows how to think about the balance sheet – namely as a picture of the company at a point in time.

The Balance Sheet respects something called the Basic Accounting Equation. The Basic Accounting Equation states that Total Assets always must equal Total Liabilities plus Equity. In SayAhh’s case, you can see that the assets (cash in a checking account) equals liabilities (zero) plus equity. Assets = Liabilities + Equity.

If you use spreadsheets to keep track of your books, you could accidentally violate the Basic Accounting Equation, but not in accounting software program. This is one of the reasons that Dick and Jane chose to use QuickBooks, even at this very early stage, as it guarantees that their books will conform to double entry accounting.

Equity is comprised of two things. The Ordinary Shares equity account represent the par value paid by Jane and Dick for their 10M shares ($100). The Paid-In Capital account shows Jane paid in an additional $50,000. Combined these two amounts equal total equity, or $50,100.

The other accounting document we are introducing today is the Statement of Cash Flows (SCF). The SCF breaks down how changes in balance sheet accounts and income affect cash. When presented in the SCF, these transactions are broken down into three categories: operating, financing and investing activities. Note the interconnected nature between these statements. The net $50,100 from financing activities all went into equity on the Balance Sheet.

Currently, SayAhh’s financials are very straightforward – even boring, but we’ve got to start somewhere. Next week we will introduce the Cap Table, and show how it changes when adding a co-founder.

  • http://www.rassoc.com/gregr/weblog greinacker

    Just a thought…perhaps you could have the company operate for a week, and have some expenses and income, and show how that gets reflected in the above…

    edit: and perhaps also buy some equipment, like computers and such?

  • http://twitter.com/peteskalla Peter Skalla

    Brad, I’ve seen this done where the founder putting in $50k waits a month or so to put the cash in and then invests at, say, $0.05 per share, so she receives shares directly for the cash.  I’ve also started hearing about ‘Founders Preferred,’ in which the $50k goes in as debt that is converted to preferred of the company’s seed or A round.  I see some advantages to these approaches.  What are your thoughts?

    • http://www.feld.com bfeld

      Either approach works. We did it this way to make the BS and SCF a little more interesting.

      We talked about it more in the previous post about the investment and equity allocation.
      http://www.feld.com/archives/2011/07/finance-fridays-getting-started-allocating-equity-and-founders-investment.html

      • http://twitter.com/joshhug Josh Hug

        When accounting for the founder investment as “paid in capital” are there short or long term tax implications for the founder or the company?  Doesn’t sound like Jane actually received anything (stock or note) in return for their infusion of cash…  Can Jane consider the “paid in capital” as part of her basis in the event of a liquidation?

        • http://www.feld.com bfeld

          Jane received common stock representing 55% of the company for her contribution. Assuming she filed an 83b election, she’ll have capital gains treatment and no income issues associated with vesting.

  • http://www.feld.com bfeld

    Yup – coming up soon!

  • http://www.feld.com bfeld

    Yup – coming up soon!

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