The Balance Sheet
The balance sheet tells you how much a company owns in its assets, how much it owes in its liabilities, and the difference will be equity. Equity represents the value of money the shareholders have pumped into the company.
Assets – Liabilities = Equity
Current Assets are used up or converted into cash within one business cycle which is usually one year. The major portions of this category are cash and equivalents, short term investment, accounts receivables and inventories. Cash and equivalents and short term investments refer to items which can be liquidated quickly into cash. Short term investments is similar to cash such as bond with less than a year to maturity and earn a higher rate of return than cash.
Accounts Receivables are bills that the company has not collected but expects to be paid soon. If accounts receivables rise faster than sales, the firm is trying to get sales but relaxing its payment terms. When you see an “Allowance for Bad Debts” is the company’s estimate of how much money is owed by customers which is unlikely to be paid.
Inventories include raw materials which has not been made into finished product. Inventories are important to monitor for manufacturing and retail companies. Inventories require cash which will deprive the company from other opportunities to make profit. The less time cash is tied to inventory will have a larger impact on profitability.
Noncurrent assets are assets that are not expected to be converted into cash or consumed within reporting period. This section consist of property, plant and equipment (PP&E), investments and intangible assets. Property, plant and equipment are long term assets which consist of land, buildings, factories, furniture, equipment and machinery. Investments is money invested into long term bonds or other companies. Intangible assets consist of goodwill which is accounted for when one company acquires another. Goodwill is the difference between the price the acquiring company pays and tangible value of the target company. Goodwill is the area to scrutinize, very often company overpay their target acquisition.
Current liabilities are money the company expects to pay out within a year. You should focus on accounts payable and short-term borrowings/payables.
Accounts Payable are bills the company owes to somebody else and are due to be paid within a year. Large companies can delay paying their subcontractors or suppliers which means holding on to their cash longer which is better for cash flow management. Short-Term borrowings/ payables refers to money the company has borrowed for a term of less than a year to meet short term requirement. This can lead to financial crisis if the company does not have sufficient cash or means to refinance.
Noncurrent liabilities are money the company owes one year or more in the future. The key is long term debt which represents money the company has borrowed by issuing bonds or from bank which does not need to pay back for a few years.
The only account worth looking at is retained earnings which basically records the amount of capital a company has generated over its lifetime minus dividend and stock buybacks. Retained earnings is a cumulative account, each year when the company makes money and does not pay it all out as dividends, retained earnings increase. If company loses money over time, retained earnings can turn negative and become “accumulated deficit”.