Post on 07-Nov-2014
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BALANCE SHEET ANALYSIS
HOW WE CAN READ A BALANCE SHEET
A balance sheet is divided into three main parts:
• Assets: Anything having value that the company owns
• Liabilities: the opposite of assets. Anything that costs the company money
• Shareholder’s Equity: what is left for the shareholders after the debt is paid
A balance sheet must balance:
• Assets= Liabilities + Shareholder’s Equity
A SAMPLE OF A BALANCE SHEET
Coca-Cola CompanyConsolidated Balance Sheet - January 31, 2001
Current Assets Dec. 31, 2001 Dec. 31, 1999
Cash & Equivalents $1,819,000,000 $1,611,000,000
Short Term Investments $73,000,000 $201,000,000
Receivables $1,757,000,000 $1,798,000,000
Inventories $1,066,000,000 $1,076,000,000
Pre-Paid Expenses $1,905,000,000 $1,794,000,000
Total Current Assets $6,620,000,000 $6,480,000,000
Long Term Assets $8,129,000,000 $8,916,000,000
Property, Plant, & Equipment $4,168,000,000 $4,267,000,000
Goodwill $1,917,000,000 $1,960,000,000
Total Assets $20,834,000,000 21,623,000,000
Current Liabilities
Accounts Payable $9,300,000,000 $4,483,000,000
Short Term Debt $21,000,000 $5,373,000,000
Total Current Liabilities $9,321,000,000 $9,856,000,000
Long-Term Liabilities
Long-Term Debt $835,000,000 $854,000,000
Other Liabilities $1,004,000,000 $902,000,000
Deferred Long Term Liability Charges $358,000,000 $498,000,000
Total Liabilities $11,518,000,000 $12,110,000,000
Shareholders' Equity
Common Stock $870,000,000 $867,000,000
Retained Earnings $21,265,000,000 $20,773,000,000
Treasury Stock ($13,293,000,000) ($13,160,000,000)
Capital Surplus $3,196,000,000 $2,584,000,000
Other Stockholder Equity ($2,722,000,000) ($1,551,000,000)
Total Stockholder Equity $9,316,000,000 $9,513,000,000
CURRENT ASSETS
Assets that easily can be converted into cash. They are also called liquid assets. Current assets are typically made of:
• Cash & cash equivalent• Short term investment• Receivables• Inventory• Pre-paid expenses
CASH AND CASH EQUIVALENT
Cash and Cash Equivalent is the amount of money the company has in bank accounts, savings, certificates of deposit, ….
It tells you how much money is available to the business immediately
Generally speaking, the more cash on hand the better: pay dividends, repurchase shares, pay debt, …
SHORT TERM INVESTMENTS
Investments that the company plans to sell shortly or can be sold to provide cash.
Short term investments are not as liquid as money in a checking account, but they provide added cushion if needed.
Short Term Investments become important when a company has so much cash. The company can use some of its cash to buy treasury bills (bonds having a maturity of less than 1 year).
ACCOUNTS RECEIVABLE
It is money that is owed to a company by its customers. When for instance the company sells its products on credit, this is recorded under ‘‘accounts receivable’’ in the balance sheet
Generally a company that sells a product on credit sets a term for its accounts receivable. The term is the number of days customers must pay their bill before they are charged a late fee or turned over to a collection agency (most terms are, 30, 60 or 90 days).
While accounts receivable are good, they can bring serious problems to the company if they are not managed properly.
ACCOUNTS RECEIVABLE TURNOVER
Credit Sales ÷ Average Accounts Receivables
This ratio tells how long it takes to the firm to collect its receivables. In other terms, how long it takes to convert its sales into dollars
The sooner the better!
The company can put the cash in the bank and earn interests, pay down debt, or make investment
ACCOUNTS RECEIVABLE TURNOVER:EXAMPLE
H.F. Beverages is a major manufacturer of soft drinks and juice beverages. It sells to supermarkets and convenience stores across the country on a 30 day term
In 2009, H.F. Beverages reported credit sales of $15,608,300 and had $1,183,363 in receivables and in 2008, $1,178,423. Is the firm managing well its receivables ?
INVENTORY
Inventory consists of merchandise a business ownsbut has not sold. It is classified as a current assets because investors assume that inventory can be sold in the near future, turning it into cash.
The Risks of Too Much Inventory:
1- the risk of obsolesce2- the risk of spoilage
INVENTORY TURNOVER
Cost of Goods Sold ÷ Average Inventory for the period
Coca Cola reported in 2000 cost of goods sold of $6,204,000,000. The average inventory value between 1999 and 2000 is $1,071,000,000. The average inventory turnover for the industry is 4.8.
1-What is the inventory turnover of Coca Cola in 20002- What is the number of days Coca Cola needs on average to sell its inventory
IMPORTANT POINT ABOUT INVENTORY
When analyzing a balance sheet, it is very important to look at the percentage of current assets inventory represents.
If 70% of a company's current assets are tied up in inventory and the business does not have a relatively low turnover rate (less than 30 days), it may be a signal that something is seriously wrong and the company may have liquidity problems
McDonald's vs Wendy’s
Which company is better managing inventory?
McDonald's
2000 1999
Inventory on Balance Sheet $99,300,000 $82,700,000
Cost of Goods Sold on Income Statement $8,750,100,000
Wendy's
2000 1999
Inventory on Balance Sheet $40,086,000 $40,271,000
Cost of Goods Sold on Income Statement $1,610,075,000
PREPAID EXPENSES
Sometimes companies decide to prepay taxes, salaries, utility bills, rent. This is recorded in the balance sheet under ‘‘pre-paid expenses’’
In general, this item is not important when it comes to balance sheet analysis
CURRENT LIABILITIES
These are short term Liabilities (less than 1 year)
Current liabilities are essentially made of:
- Accounts payable- Short term debt
ACCOUNTS PAYABLE
Accounts payable is the opposite of accounts receivable. It arises when a company receives a product or service before it pays for it.
Accounts payable is one of the largest current liabilities a company will face because they are constantly ordering new products or paying suppliers.
Really well managed companies attempt to keep accounts payable high enough to cover all existing inventory, meaning that the vendors are paying for the company's shelves to remain stocked, in effect.
SHORT TERM DEBT
These current liabilities are sometimes referred to as notes payable. They represent the payments on a company's loans that are due in 1 year.
Is Borrowing money a sign of financial weakness? Think about leverage and financial distress
If, on the other hand, the notes payable has a higher value than the cash, short term investments, and accounts receivable combined, you should be seriously concerned. Unless the company operates in a business where inventory can quickly be turned into cash
WORKING CAPITAL
Current Assets - Current Liabilities = Working Capital
Poor working capital usually leads to financial pressure on a company, increased borrowing, and late payments to creditor - all of which result in a lower credit rating. A lower credit rating means banks charge a higher interest rate, which can cost a company a lot of money over time
So, even a business that has billions of dollars in fixed assets will quickly find itself in bankruptcy if it can't pay its monthly bills! -Liquidity versus solvency-
NEGATIVE WORKING CAPITAL
Companies that have high inventory turns and do business on a cash basis (such as a grocery store) need very little working capital.
Since cash can be raised so quickly, there is no need to have a large amount of working capital available.
A company that makes heavy machinery is a completely different story. Because these types of businesses are selling expensive items on a long-term payment basis.
Think about McDonald’s and Boeing
CURRENT RATIO
Current assets/Current liabilities
It calculates how many dollars in assets are likely to be converted to cash within one year in order to pay debts that come due during the same year.
In general if the company has a current ratio exceeding 1 has no liquidity issues
Companies that have ratios around or below 1 should only be those which have inventories that can immediately be converted into cash. If this is not the case and a company's number is low, you should be seriously concerned.
QUICK TEST RATIO
Quick assets/Current liabilities
Quick Assets = Current Assets - inventory
This ratio is also called Acid Test or Liquidity ratio
The Quick Test ratio does not apply to companies where inventory is almost immediately convertible into cash (such as McDonalds, Wal-Mart, etc.) Instead, it measures the ability of the average company to come up quickly with cash. Since inventory is rarely sold that fast in most businesses, it is excluded
LONG TERM ASSETS
Assets a company owns but cannot be used to fund day to day operations
Examples of long term assets include:
- Long term investment- Fixed assets
LONG TERM INVESTMENTS
Investments a company intends to hold for more than one year. They can consist of stocks and bonds of other companies
They also include stock in company’s affiliates and subsidiaries
FIXED ASSETS
Assets such as buildings, real estate, office furniture are called fixed assets
They are also referred to as PP&E (Plant, Property & Equipment)
INTANGIBLE ASSETS
Companies often own things of value that cannot be felt.
These consist of patents, trademarks, brand names, franchises, and economic goodwill.
Economic goodwill consists of the intangible advantages a company has over its competitors such as an excellent reputation, strategic location, etc.
When analyzing a balance sheet, ignore the amount assigned to intangible assets. They may be worth a huge amount in real life, but it is the income statement, not the balance sheet, that gives investors insight into the value of these intangible items
ACCOUNTING GOODWILL
Goodwill is the difference between market and book value when buying a business
It is the "premium" a company pays when it acquires another, the amount it pays is called the purchase price.
Accountants take the purchase price and subtract it by a company's book value. The difference is recorded in the balance sheet under Goodwill.
SHAREHOLDER’S EQUITY
It is the money of shareholders
The following items are components of the Shareholder’s Equity:
- Capital- Retained Earnings - Reserves- Treasury stock (an item that reduces equity)
LONG TERM DEBT
Liabilities that have a maturity exceeding 1 year
- Bank loans (more than 1 year)- Bonds
Debt to Equity ratio =
Short and long term debt/ Shareholder’s Equity