BALANCE SHEET— WHAT & WHY?
A two-column table that helps you to identify total assets, and what it takes to acquire those assets at a particular point in time.is known as the Balance Sheet.
Two-column are categorized as:
a) Assets
b) Liabilities and Shareholder’s Equity.
These two columns must be equated as
Assets = Liabilities + Shareholder’s Equity
What do these terms mean and do they constitute anything within them or standalone?
If we talk about Assets then assets can be summarized as cash or cash equivalents, further divided into two sub-categories:
a) Current
b) Non-Current
Liabilities on the other hand display the amount of money that a company owes, further divided into two sub-categories:
a) Current
b) Non-Current
Assets
Current Assets
Current as name summarised itself which is cash itself or can be converted into cash within a year. Some of the Current assets are:
a) Cash and Cash Equivalents -Cash equivalents include bank accounts and marketable securities, which are debt securities with maturities of less than 90 days.
b) Accounts Receivables -Legally binding bills on which goods or services are rendered on credit.
c) Inventory -Goods that are ready to sell.
d) Prepaid Expense- Expenses that are already paid but not due.
e) Short-Term Investments -They include Bank accounts or any other investment which can be liquidated at any time.
Non-Current Assets
are those which are cash equivalent but can only be converted into cash after a year. Some of the Non-Current assets are:
a) Property, Plant, and Equipment -Land, Machinery, or any other fixed asset purchased for production or any other business-related activity.
b) Intangible Assets -Goodwill (Nike’s name plays a vital role in its sale.) Other examples are patents, copyright, franchises, trademarks, and trade names, as well as software
c) Capital Work-in-Progress -Capital used for any fixed asset is considered under capital work in progress.
d) Financial Assets -Investment in Long-term Bonds, Equity holding more than 1 year.
e) Investments -Investment in fixed assets that are not the primary part of the business.
f) Loans -Any long-term loan provided to any individual or a firm.
g) Deferred Tax Assets (Net) -Advance payment of tax.
Liabilities
Current Liabilities
The money which the company owes and has to re-paid within a year is categorized under Current Liabilities.
a) Account payables -Money owed to the suppliers.
b) Un-earned revenues -Payment received but the services are due also known as deferred revenue or advance payment.
c) Notes Payables -Legally binding contract indicating the future payment owed by the company.
d) Current portion of Long term Debt -It is the amount of unpaid principal from long-term debt that has accrued in a company’s normal operating cycle (typically less than 12 months). It has to be paid within that period.
Non-Current Liabilities
a) Bonds Payables -Amount due to bondholders (Entities who purchased bonds of a company for a fixed period of time for a specific Interest rate {either variable or fixed}).
b) Long Term Debt -Long-term loan is taken by a company for Expansion or to Re-structure.
c) Deferred Tax Liabilities -Any tax amount which is due to the tax authorities.
d)Provisions -Amount kept aside for future uncertainties by the company.
Share Holders Equity
Indicates the amount invested by the owners of the company. Three categories to it are:
a) Common Shares -Shares that are issued to the owners or investors of the company.
b) Retained Earnings -Part of Net Income which is left after distributing dividends to the common shareholders.
c) Preferred Shares -Those shares which have the priority to dividends before common shareholders.
This Summarises the part of the question what.
WHY BALANCE SHEET IS SO IMPORTANT?
Financial statements are an integral part of any organization, which clarifies the investor about its future growth and where the company stands.
The balance sheet helps to evaluate the health of the company at any particular point in time.
Benefits of Balance Sheet:
A) It helps in evaluating Operational Efficiency -Current assets & Liabilities column on the balance sheet display the efficiency of operations of a company as a measure of Accounts receivable and payables, Increase or decrease in Inventory.
B) Determine the Financial Health -Liabilities being the sources of Funds and assets being the outcome of those funds determine the health of the company as how much debt is taken to acquire those assets, mainly their ratio analysis.
C) Helps in Comparison -Converting the balance sheet in the common size statement helps in comparing the company’s health with its peer in the industry.
D)Maintain Liquidity -Liquidity ratios such as Current, Quick helps the company to check its liquidity position from time to time and help the company to maintain it.
Having such a benefits Balance sheet also has some limitations to it, which a good analyst will keep in mind before coming to any conclusions.
A) Use of Historical Data -All the figures representing in the balance sheet are based on historical numbers thus, the need for accurate prediction of the prospects of the company is a must.
B) The Concept of Inflation -Inflation is the number at which the prices rise in the coming time, thus predicting and inserting inflation in the future prices is important.
C) Opportunity for Window Dressing -Window dressing means making the balance sheet more attractive to investors by adding fictitious columns in the balances sheet which actually are not part of the actual balance sheet.
D) Time Effect -With time, the value also suffers, say Currency exchange value, the rise and fall of the currency can actually change the predicted values.
Summary
Balance Sheet is a two-column statement, easy to understand and read with complexities built within it. Key points to keep in mind while assessing any balance sheet of a company:
A) The formula : Assets = Liabilities + Shareholder’s Equity.
B) Always understand the business model first, so that any window dressing could be easily identified.
C) It's easy to compare with peer companies, thus always convert the balance sheet into a common-size statement for better and accurate analysis.
D) Look out for the out-of-the-box items. Say, Service Industry companies are unlikely to have stocks(Physical) in their balance sheet.
