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Current time:0:00Total duration:9:54

Video transcript

welcome well there's been a lot of news lately about what's going on with Bear Stearns and and Carlile capital and and I go to these parties and I start explaining to people because it's very exciting and it's actually very important to all of our collective futures and the whole help of the financial system and I feel like people's eyes start to glaze over so with that in mind I decided to to take a little bit of hiatus from kind of the core math and physics videos and actually do some some accounting and Finance videos because I think what's happening in the world right now is extremely extremely important and I'm not just going to go straight into what's going into you know Carlyle and Thornburgh and and all of these characters because I think the newspapers do that but a lot of people don't understand kind of the basic accounting and what is a writedown what does it mean when you don't have liquidity in really tangible way so I'm going to use kind of the same Khan Academy techniques to hopefully explain some of this so I'm going to start with just a very basic accounting a basic accounting concept of the balance sheet and 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 million dollars for this house and I like the house and I think that's a fair price other houses in the neighborhood also went for a million dollars or whatever maybe they went for more so I think it's actually a good deal but all I have in my pocket although not all I have in my pocket is is all I have is to have 250,000 dollars so 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 so what is my pre my before house balance sheet but what are my assets so let's say I'm go right down assets assets but before we know what my assets are let me tell you what an asset is an asset is something that has 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 to get stuff from people or make them do things or buy stuff you can you know in a month from now you can use your cash and you can 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's dancing for you is an actual economic benefit but 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 acid is so what is 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 and I have $250,000 worth of cash now what are my liabilities liabilities I'm going to write the liabilities on the left hand side I think that's the convention but I forget but it doesn't matter what are my liabilities well a liability is something that it's an obligation to someone else kind of an economic obligation to someone else so if you know 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 that could be a liability would be hard to value but that's something that I have to do in the future but what are my liabilities here one of the example I gave I'm just Sal I have no dad I've paid off my college loans everything and I have two hundred and fifty thousand dollars 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 liabilities so what is my equity 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 assets a for assets is equal to liabilities plus equity right so in this case our assets are $250,000 my liabilities are what I owe know I know I owe nothing to anyone 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 right my equity is also $250,000 so in this case if I made a balance sheet before I enter into any transactions and let me make it look a little bit like a like a balance sheet my assets are $250,000 I have no liabilities and then my equity equity would be $250,000 and if I were to draw this graphically actually should probably draw it like this I have no liability so let me let me draw another little mini balance sheet here let me draw it as a neat square now you probably can't see that square let me switch colors too so I put my assets on the right hand side and I'll say there I'll have 250k of cash and the left hand side I have no liabilities and I will just say I have equity of 250 now equity might not make a lot of sense to you right now because I'm kind of justing well my equity is equal to my cash in general equity is just what you own what 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 left over 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 million dollar 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's let me draw draw the bank this is the bank the big dollar sign it's 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 of the silly things that they do but they do many silly things we're going it later but the bank is going to give me another $750,000 in cash right and in return I'm giving them essentially an IOU an IOU and I'm going to pay interest right so they're going to hold this little security that says Sal owes me $750,000 and he has to give me you know 10% interest every year so $75,000 a year or something like that and in return I get $750,000 so what does my balance sheet look like now let me draw it let me make sure my balance sheet now looks let me draw it like a square cuz I think the visual representation is helpful so and then I will split it so what are all my assets now I had $250,000 and now I got another $750,000 right I got another 750 thousand dollars from the bank so now what are my assets well 250 plus 750 and now have cash of 1 million dollars 1 million dollars what are my liabilities will my liability that's something that I owe to someone else why I owe the bank $750,000 so liabilities I'll just say ll4 liabilities because I'm running out of space and 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 I mean we look at this formula right assets equal liabilities plus equity if this is a million this is 750 what is 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 making is starting to make a little more sense now we have it you know I could say that I have a million dollars and some people are like that they think they're a millionaire when they have a million dollar of assets but they don't consider well they might have a million dollar 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 heir but your assets might be a million dollars but you're not nearly a millionaire because you still owe other people 750 thousand what you have left over that really is your net worth or you know what you can have claim to and that's your equity sometimes it's called owner's equity or if there was a bunch of people pitching together it'd 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 sheets starting to make a starting to seem a little bit useful but I have the cash and I've took the load 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 house to the owner the old owner of the house or maybe this Toll Brothers they just built this McMansion for me so I give them 1 million dollars and in return they give me the deed to the house or they I could just say they give me the house right it's the house is always there but you know it's really just the contract and all the legal structure that I get around it and all the property rights and all of that but that gets getting too philosophical so now what does my balance sheet look like instead of cash and I think I'm running out of space and time to draw another balance sheet I don't have cash worth of million dollars I now have a house worth a million dollars 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 million dollar 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 will start to get learn a little bit more about what's going on in the world see you soon