I have started this 3 blog series to cover the basics of financial statements. In the first part, I have explained the difference between an asset and a liability. If you think a bit hard, you will understand why Robert Kiyosaki always says, “Your house is not an asset”.
Why it isn’t? Because you pay the maintenance, property taxes, and wear and tear of that property, and if bought on a mortgage, you pay interest. The only hope you have is someone pays you a higher price. And remember, that during the 2008 recession, home prices had crashed. An asset must produce cash irrespective of its value going up or down. Warren Buffet would like it if the stocks he owned went down so he could buy more stocks of those companies at much lower prices. He would do so because he has studied the company in detail and knows that the company would give great returns in the future.
In terms of accounting, everything having a value is considered an asset but from Robert’s standpoint, the cash flow from the investment instrument reveals its actual behavior. If you correlate an investment instrument to a verb, the cash flow is the adverb. I have explained multiple examples in the previous blog (Updated Monopoly: The Cashflow game (part 1). It is not a pre-requisite, but why do it half-heartedly so give it a look…
Updated Monopoly: The Cashflow Game (Part 1)
Just a revision: There are three kinds of financial statements-
1. Balance Sheet
2. Income Statement
3. Cashflow Statement
Important Note by Robert Kiyosaki: “An Asset is something that puts money in your pocket and liability is something that takes money from your pocket”
Income Statement of Individuals:
What you can see above is an individual’s income statement. Whatever the source of income for individuals, their first expense is their income tax. Different governments of different jurisdictions incentivize certain expenses and investments deductible from salary so that individuals can pay less tax on their overall income.
Income Statement of Corporates:
Could you clarify the difference? It is visible that the first expense is not tax, so businesses can spend money on people, teams, and other business parameters. However, if they make a profit, they will be taxed just on that.
So let’s imagine, a company called ABC Corp is earning $ 1 billion in total revenue, after all expenses they make a profit (before tax) of $200 million, assuming corporate tax is 21%, they would pay a tax expense of $42 million. If you want to learn how they save even this amount, there are numerous case studies online on this topic.
Why do corporations pay less in taxes?
Governments around the world do so because they want others to take the risk of creating value and jobs, the primary focus of the government is to create an environment where businesses can thrive. When a country has corporations, they create employment and provide goods and services. The employees pay the taxes so that governments can run. It is not like, companies don’t pay taxes, it is just that the governments incentivize them to do certain things and take the risk of failure, which the governments are reluctant to do.
For example, there is an effort to curb oil imports in India and to make the country energy-independent. The country loses hundreds of billions of dollars on oil and gas imports. To reduce this import and the carbon emissions caused by burning these fuels, the Government of India is pushing heavily for renewable energy and green hydrogen. They have given various incentives to entrepreneurs to create value in this space. There are numerous subsidies offered to players in this space. Similarly, the GOI has encouraged domestic oil and gas exploration and chip manufacturing. The PLI scheme is designed to incentivize players to increase their production capacity.
For individuals, Provident fund contributions, contributions to National Pension Schemes, and many more are tax deductible (check the link and consult a professional). The point I make here is the first expense of an individual earning a salary is TAX, and no matter which jurisdiction you are working in, you don’t like the government taking a sizable pie of your hard-earned money. But for corporates, it is the last expense.
As you enter the game, the first thing displayed is your financial statement. It will be like a performance report for you throughout the game. The more assets you buy, the more passive income you will earn, and the better your skill at buying assets, the quicker you will get out of the rat race. Indeed, it can teach you a lot about the basics of financial statements. In my earlier blog, I wrote about the cone of learning.
The more you do the more you understand. Reading this has given you the idea, to implement in the simulation. So do play the Cashflow board game
In the next blog, I will discuss the third financial statement—the cash flow statement. This might seem like an income statement, but it isn’t. A person able to read cash flow statements can understand the sources of money entering a system and where it is directed. Understanding this statement can be very beneficial, as one can map their cash flow statement and, if necessary, make necessary changes. So stay tuned…
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