Balance Sheet

**xxyygorich** Sun May 07, 2006 3:34 pm

Balance Sheet
The Balance Sheet is one of the most important financial documents of a business.

I'd like to introduce the basics of the Balance Sheet to the beginners (although I am one of them too).

The Balance Sheet is a snapshot of the finance picture of an enterprise on an instant in time. It reports at the given time point
how much the enterprise has: Assets
how much the enterprise owes: Liabilities
how much the enterprise is worth: Equity

Code: Asset - Liabilities = Equity

The balance sheet represents the rearranged form of the fomula:
Code: Asset = Liabilities + Equity . The equation must be always "in Balance".

Format of the Balance Sheet
Code:
Assets Liabilities & Equity
Cash A Account Payable K
Accounts Receivable B Accrued Expenses L
Inventory C Current Portion of Debt M
Prepaid Expense D Income Taxes Payable N
----------------------------- ----------------------------------
Current Assets E = A + B + C + D Current Liabilities O = K + L + M + N

Other Assets F Long Term Debt P

Fixed Assets at Cost G Capital Stock Q
Accumulated Depreciation H Retain Earning R
------------------------------ ----------------------------------
Net Fixed Assets I = G - H Shareholders' Equity S = Q + R

Total Assets J = E + F + I Total Liabilities & Equity T = O + P + S
============================== ===================================

Because the terms of the Balance Sheet are very straight forward, I only provide a few highlights and some simple explainations.
Explainations and Highlights:
Code:
A. Cash: Cash.
B. Account Receivable: The colloection rights to its customer who had received goods but not yet paid.
C. Inventory: includes Raw material inventory,
Working-in-progress inventory,
Finished goods inventory.
D. Prepaid Expense: bills were paid, but services are not yet received.
E. Current Assets Cycle:
Cash buys Inventory -> Inventory sold becomes Account Receivable
^ |
| V
| Account Receivable upon collection becomes Cash
| |
|-----------------------------------------------------------------------------|

F. Other Assets: Not current assets, not fixed assets, includes intangible
assets, such as a patent or a brand name. They are valued by
management, might be very arbitrary.
G. Fixed Assets: PP & E (Property, plant and equipments.)
H. Depreciation: spreading the cost of aquiring the asset over the asset's useful
life. It will lower the profit but not cash.
I. Net Fixed Assets: is NOT necessarily relate to an actual decrease in value.
Some even appreciation in value.

K. Account payable: debts to suppliers or service provider.
L. Accured Expenses: salaries, interests and so on
M. Current Portion of Debt: Loan < 12 month + current portion of long term loan (> 12 month).
N. Income Taxes Payable: Taxes;
O. Current Liabilities:
Current Assets - Current Liabilities = Working Capital (Net Current Assets)
The higher the working capital a company has, the easier for the company to pay its financial obiligations.
S. Shareholders' Equity: companies value left to its owners.
Shareholders' Equity = Total Assets - Total Liabilities;
Consists of 2 parts:
1. Q. Capital Stock. Original investment.
2. R. Retained Eairnings: All earning retained, not paid out dividends.

To increase Shareholders' Equity, either company makes profits (increasing R), or sells new stocks (increasing Q).

What can we get from the Balance Sheet ALONE ?

The messure of short term financial strength.
Code:
Current Ratio = Current Assets / Current Liabilities = E / O
Quick Ratio = (Cash + Receivables) / Current Liablities = (A + B) / O

In general, CR > 2 is considered good. The company has a financial cushion for the short term bills.
Quick Ratio is more conservative measure of liquidity than the current ratio.

The messure of Leverage.
Code:
Debt to Equity = (Current + Longterm Debt)/ Shareholders' Equity = (M + P) / S
Debt Ratio = (Current + Longterm Debt)/ Total Assets = (M + P) / J

The leverage is the use of others' money to generate profits for yourself.
A low level of debt relative to equity will give the lenders more comfort that loan will be repaid (if things go bad).
Debt Ration is a messure of operating leverage.
These ratios can be used in comparisons across similar competitors to see if the company we are interested in is in a good position.