Posted by Hey everybody, Andre here at the Coach’s Hangout with a study tip. If you’re having difficulty understanding a concept, be like Pinocchio and stretch the story a little bit. Sometimes exaggerating a concept, on either extreme, can make it way easier to see. It can make a concept you may otherwise be unsure about become crystal clear. Let me show you what I mean by looking at a couple of concepts that deal with a company’s statement of financial position (also referred to as a balance sheet). One that is easy to understand if you think of a small company, while the other is easy to understand if you think of a huge one.
Concept #1: Would an increase in retained earnings impact a corporation’s equity?
In this case, don’t think of a huge, complicated conglomerate–that’s way too confusing; instead, pretend you own 100% of a small business. Ask yourself, if that business earns $1 Million and you retain all that money in the business, how would it impact your equity in that business? It’s easy to see that your equity would go up and you would be one happy camper.
Concept #2: Would a change in the price of common shares trading in the secondary market impact the issuing corporation’s equity?
In this case, it helps to think of a large company. Ask yourself, if you are desperate for cash, and you decided to sell your shares of a huge conglomerate (like Amazon) at a rock bottom price at 2:00 AM during a poker game, do you really think that would directly impact Amazon’s financial statements? The answer to that question, of course, is no. In that situation, Amazon wouldn’t even know. To use an analogy, this is no different than selling your home in the secondary housing market. The sale price would impact you as the seller, and it would impact the buyer, but it would have no direct impact on the builder, even though they were the original issuer of that home. We dive into this concept a little more in the SeeWhy Learning study guide.
If you’re thinking, “Okay, Andre, you sold me. I can see how exaggerating a concept can really help, but I wouldn’t know when and how to do that.” Well, I have some great news for you. The trainers at SeeWhy Learning have already done all that work for you. Check out our full suite of study tools at SeeWhyLearning.com.