How To Represent Finance

Now let's expand upon our example, and add in financing of the purchase of the car with a loan. The gold and yellow bars, (in the spreadsheet) indicate the changes that we're going to have in our income and our cash flows because of these two pieces, (the car, and the loan to finance the car.) Now, the loan that I am creating for the purchase of this car is really simple, all it is is to borrow money in 2010 and in 2011 you make one payment, so the payment's going to have all the principal and interest packed up together in it. And so it's just going to be you're going to borrow $10,000, (source in cell D17) and then you're going to pay back $11,000, (principle = cell E17 = -10000 and interest = cell E4 = 1000) because the interest rate is 10%. So let's go ahead and show you where the $10,000 comes in, and the place that you are going to see that you took out a loan is down here in the cash list, (flow) statement under this new section we've created called finance. That $10,000 right there, (in cell D17) is the loan. Now, what that means is that the loan is going to be a source of cash, so it's going to indicate cash that's going in, a positive cashflow source. None of this other stuff changes; the car is still there as a negative $10,000, (in cell D17) and there is still cash going out because of it, but, what you are going to see is that because you borrowed money, you have this new source of cash come into it, and that's how you're going to see a loan, that's how you're going to see this financed.

Now the other thing that I've added is going to be this interest expense. Now, please note, the year you take out this loan there isn't going to be interest expense. What we're doing is we are moving that all over into the second year. The idea is you borrow $10,000, there's a 10% interest rate on it and so your payment in the year 2011 is supposed to be $1100. Now please note, like we've discussed before, the payment on the loan gets split into two components. Some of it ends up being an interest expense and that's just that $1000 that's right there, (in cell E4) and that's what you're seeing; this positive number indicating that there is an expense right there. The other part is going to be the principal payment and the principal payment shows up down in the cash flow statement as a negative number because that's cash that's flowing out. But if you just go ahead and add the $1000 together with this $10,000, (please ignore the negative sign) you see the full $11000 payment that's right there, (summarized in cell G4.)

Now look what happens in the year that we have up here that we've made a couple of different assumptions. First we're going to say in 2011 that that change in operating revenue from the state where we don't have or didn't make the purchase of the car is now zero. So an interpretation of this is that in 2010 we kind of like bought the salesperson a new car, salesperson got excited and we ended up with a $1000 worth of additional sales, but the next year the salesperson is not so excited, because you know, it's the same old car that they had last year. And so while sales originally spiked because you purchased this vehicle, they're back down to what they would have been if you hadn't actually purchased this new vehicle. Now, again, this is the interpretation we're going to have to the numbers and actually what we'll do is we'll say that’s going to happen in every year thereafter, ok? So what we're seeing is a single year spike in sales increase because we purchased this vehicle. This does not mean the level of sales in 2011 is the same as in 2010. What it means is the level of sales in 2000 is back down to what it was if we had not purchased the vehicle.

Now, our operating expenses are also going to be as low as they were before - they are going to be $1500 less than what they would have been if we hadn't purchased the vehicle, so let's be clear on those interpretations. The next element that we have here is this new interest expense, (in cell E4.) Please note that this is this extra addition, it's an extra expense and I've added in depreciation of $3200, which is what you have in the second year you own a 5 year asset, it's just going to be 32% of the cost basis which is $10,000, (what the property cost when it was purchased , placed into service, or converted to business use.) Now, taxable income in this second year you own the asset is going to be a negative number because look at what we're doing right here we are taking our operating revenue, (in cell E2) and we are subtracting off all those other expenses, and so what you're noticing is that your taxable income is actually lower in the second year that you own the asset rather than higher, and so, you have a reduction in this taxable income relative to what it would have been if you had not purchased the vehicle.

You’re also going to have a reduction in taxes, and that’s what that negative number there in the taxes indicates, (taxable income, cell E6.) Now, negative means that your tax burden has gone down relative to the state where you did not purchase the vehicle, okay? If it was positive it would mean that your tax burden has gone up relative to the state where you purchased the vehicle. Now remember all that we're doing with taxes here is we're just taking that taxable income and we're multiplying it by our tax rate, which is 50%. The space below that is just the net income I am echoing back, as we've explained in the other vehicle the net income is a source of cash, depreciation is a source of cash, but here's the important part; there's this giant sink of cash because we made our loan payment and that $10,000 that we have right there, (in cell E17) represents our principal payment. Now as we've had in the past, that net cash flow, it's just going to be the sum of all these sinks and sources of cash. So though the first year, (2010) looks great because we had this loan, in the second year, [2011, we experienced a decrease in net cash flow relative to the state where the vehicle was not purchased.]
Now let's expand upon our example, and add in financing of the purchase of the car with a loan. The two gold and yellow bars indicate the changes that we're going to have in our income and our cash flows because of these two pieces. Now, the loan that I am creating for the purchase of this car is really simple, all it is is to borrow money in 2010 and in 2011 you make one payment, so the payment's going to have all the principal and interest packed up together in it. And so it's just going to be you're going to borrow $10,000 and then you're going to pay back $11,000 because the interest rate is 10%. So let's go ahead and show you where the $10,000 comes in, and the place that you are going to see that you took out a loan is down here in the cash list statement under this new section we've created called "Finance", and that $10,000 right there is, this is the loan. Now, what that means is that the loan is going to be a source of cash, so it's going to indicate cash that's going in, a positive cashflow source. None of this other stuff changes, I mean the car is still there as a negative $10,000. There's still cash going out because of it, but you're going to see that because you borrowed money you have this new source of cash come into it, and that's how you're going to see a loan, that's how you're going to see this financed.

Now the other thing that I've added is going to be this interest expense. Now, please note, the year you take out this loan there isn't going to be interest expense, what we're doing is we're moving that all over into the second year. The idea is you borrow $10,000, there's a 10% interest rate on it and so your payment in the year 2011 is supposed to be $1100. Now please note, like we've discussed before, the payment on the loan gets split into two components. Some of it ends up being an interest expense and that's just that $1000 that's right there and that's what you're seeing, this positive number indicating there's an expense right there. The other part is going to be the principal payment and the principal payment shows up down in the cash flow statement as a negative number because that's cash that's flowing out. But if you just go ahead and add the $1000 together with this $10,000, please ignore the negative sign, you see the full $11000 payment that's right there.
Now look what happens in the year that we have up here, we've made a couple of different assumptions. First we're going to say in 2011 that that change in operating revenue from the state where we don't have or didn't make the purchase of the car is now zero. So an interpretation of this is that in 2010 we kind of like bought the salesperson a new car, salesperson got excited and we ended up with a $1000 worth of additional sales, but the next year the salesperson is not so excited, because you know, it's the same old car that they had last year. And so while sales originally spiked because you purchased this vehicle, they're back down to what they would have been if you hadn't actually purchased this new vehicle. Now, again, this is the interpretation we're going to have to the numbers and actually what we'll do is we'll say that’s going to happen in every year thereafter, ok? So what we're seeing is a single year spike in sales increase because we purchased this vehicle. This does not mean the level of sales in 2011 is the same as in 2010. What it means is the level of sales in 2000 is back down to what it was if we had not purchased the vehicle.

Now our operating expenses are also going to be as low as they were before, they are going to be $1500 less than what they would have been if we hadn't purchased the vehicle, so let's be clear on those interpretations. The next element that we have here is this new interest expense. Please note that this is this extra addition, it's an extra expense and I've added in depreciation of $3200, which is what you have in the second year you own a 5 year asset, it's just going to be 32% of the cost basis which is $10,000, (what the property cost when it was purchased , placed into service, or converted to business use.) Now taxable income in this second year you own the asset is going to be a negative number because look at what we're doing right here. We're taking our revenue, and that's what E2 is, and we're subtracting off all those other expenses. And so what you're noticing is that your taxable income is actually lower in the second year that you own the asset rather than higher. And so, if you have a reduction in this taxable income relative to what it would have been if you had not purchased the vehicle.

You’re also going to have a reduction in taxes, and that’s what that negative number there in the taxes indicates. Now, negative means that your tax burden has gone down relative to the state where you did not purchase the vehicle, okay? If it was positive it would mean that your tax burden has gone up relative to the state where you purchased the vehicle. Now remember all that we're doing with taxes here is we're just taking that taxable income and we're multiplying it by our tax rate, which is 50%. The space below that is just the net income and I'm echoing back as we've explained in the other vehicle the net income is a source of cash, depreciation is a source of cash, but here's the important part. There's this giant sink of cash because we' made our loan payment and that $10,000 that we have right there represents our principal payment. Now as we've had in the past, that net cash flow, it's just going to be the sum of all these sinks and sources of cash. So though the the first year looks great because we had this loan, the second year………

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