03 Balance sheet Flashcards
• The Balance Sheet provides information on what the company owns (its assets), what it owes (its liabilities) and the value of the business to its stockholders (the shareholders’ equity) as of a specific date.
- It’s called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders’ equity).
- Every day the firm engages in new transactions and the composition of the Balance Sheet changes accordingly.
- The resources of the firm are the Assets (A); the sources of capital are the Liabilities (L) and the owner’s equity (OE).
- By construction, assets are always equal to liabilities plus owner’s equity. This is known as the accounting identity:
- Assets are:
- Resources owned by the firm
- That are expected to generate future economic benefits
- That arise from a past transaction or event
- Ownership by the company is a necessary requirement for a resource to be an asset. However, not all resources are in the Balance Sheet, because some do not meet the ownership requirement.
ØFor instance, having a talented work force is clearly an important resource but, because the firm does not own its employees, they cannot be considered an asset in accounting terms.
Valuation 估值 is the process by which a monetary value is assigned to each item of the balance sheet.
• In general, all asset items are valued at the acquisition price or production cost, unless the market value is lower (fair value). 除非市场价格更低
• An asset is recognized in the balance sheet if:
a) It is likely to generate future economic benefits, and
b) These benefits can be measured reliably.
q If only one condition is fulfilled, the asset is not recognized in the balance sheet.
q Assessing whether an asset will generate future economic benefits, requires certain judgement and it is an essential task of management.
q The other aspect is the measurement of the economic benefits. Sometimes it is difficult even if it is clear that there will be future benefits.
Ø For example, a company discovers a promising new technology, but it is unable to estimate the size of the market and the revenues that it could generate. This new asset fails the measurement test and cannot be recognized as an asset.
- Liabilities are:
- Present obligations of the firm
- Arising from past events
- The settlement which is expected to result in outflows of economic benefits.
- Future obligations are not liabilities.
ØFor instance, commitments are not liabilities because they are future obligations. A firm does not recognize liabilities for the salary of employees who have yet to perform their work.
• A liability is recognized in the balance sheet if:
a) Is probable that economic benefits (such as cash) will outflow from the firm and
b) These benefits outflows can be measured reliably.
q If only one condition is met, the liability is not recognized in the balance
sheet.
q In such a case, if the value of the liability is significant, the firm discloses 披露 its existence in a note to the balance sheet.
ØLawsuits for business malpractice 诉讼 are typical examples of liabilities not recognized but simply disclosed. Quite often the firm considers that it will prevail in the lawsuits or that it is impossible to measure reliably the eventual costs of the litigation.
• Assets are classified into two categories:
qCurrent assets (CA) are the resources that are either cash or the firm expects to convert into cash, to sell, or to consume during the next 12 months (or during the firm’s operating cycle, whichever is longer).
qNon-current assets (NCA) are assets that are not current, and the firm intends to use for a long period of time to conduct its operations.
• Liabilities are classified into two categories:
qCurrent liabilities (CL) are present obligations to be paid in less than one year.
qNon-current liabilities (NCL) are present obligations to be paid in more than one year.
• Most common Current Assets:
oCash: Cash in hand and bank deposit, cash equivalents highly liquid. It is the most liquid asset of the firm.
oShort-term financial investments in debt or equity instruments with maturities between 3 and 12 months, such as bonds and shares of other firms.
oAccounts receivable: The amounts owed to the business by the customers, reported net of defaults. 顾客欠的
Inventory: Products purchased or produced by the firm that are held for sale:
oRaw materials: items to be used in production
oWork in progress: items undergoing production
oFinished goods: products ready for sale
q Inventories are valued at acquisition cost or production cost (all the costs incurred to make the products)
qIf inventories become obsolete or prove difficult to sell, they must be written down using a “lower-of-cost-or-market” rule. The goal is to avoid having an overstated asset on the balance sheet.
oPrepaid expenses: payments for insurance, rent, etc. that will provide benefits in the future.
oInterest receivable. Interest earned on the firm’s investment not yet received.
oTaxes receivable. Taxes not yet returned by the tax authorities.
• Most common Non-Current Assets:
oProperty, plant and equipment. These are long-lived assets with physical substance that the firm intends to use in its operations for a long period. Even though the firm can sell these assets, it is not its intention to do so.
ØThink about one firm that uses cars in its operations vs. another company who produces cars. How will they recognise this asset?
oReporting property, plant and equipment:
qSome firms report the original cost of these assets and, below, a negative line called accumulated depreciation, which contains all the depreciation recognized up to the balance sheet date. (see Walmart in the Exhibit)
qDepreciation is an allocation of the cost of the depreciable assets to different accounting periods to take into account that these assets lose value because of usage.
oDeferred tax assets: Income taxes recoverable in the future
oFinancial investments: Long-term investments of the firm in debt or equity securities.
oIntangible assets: Long-lived assets with no physical substance and not financial in nature:
oAcquired patents
oR&D expenses (that have been capitalized).
oCopyrights and trademarks qIf these assets do not have indefinite lives, they must be amortized in a systematic way.
qAmortization is the word used for depreciation when the assets are intangible.
oGoodwill. This is an intangible asset that only arises when a firm acquires another firm. It captures the value of intangibles that cannot be separated from the rest of assets acquired:
ØGrowth opportunities,
ØThe reputation of the acquired firm,
ØThe know-how of its workforce,
ØSynergies of the resulting company, etc 协同作用
oGoodwill recognition:
qThese elements cannot be sold separately, for that reason they are lumped together in this asset.
qGoodwill is assumed to have indefinite life and it is not amortized.
qNevertheless, goodwill must be tested for impairment every year. An impairment test verifies that the asset has not lost value during the period. If this were the case, the goodwill would be written down and the firm would recognize a goodwill impairment loss.
ØGoodwill: Example:
§ Company A acquires Company B for €10M
§ Company B:
§ Assets at market value: €9M
§ Liabilities at market value: €2M
§ What amount is paid for B’s Goodwill?
§ B’s Net Assets = Total Assets market value – Total liabilities market value
§ B’s Net Assets = €9M - €2M = €7M
§ Goodwill = Cost of purchase – Net Assets = €10M - €7M = €3M.
• Most common Current Liabilities:
oAccounts Payable. The amounts owed to suppliers of merchandise, services and goods. It represents a company’s obligation to pay off a short-term debt to its creditors.
oSalaries payable, utilities payable, interest payable. These are amounts owed by the firm to employees, utility companies and lenders.
oTaxes Payable. Amounts owed to tax authorities.
qPurchasing taxes payable (VAT): These amounts are invoiced by suppliers at the time of purchase and held until payment.
oShort-term loans. Borrowings due in the next 12 months. This debt is made of:
oShort-term bank loans taken out by a company
oCurrent portion of long-term loans that is due in less than a year. (see Exhibit)
oAdvances from customers or deposit from customers or deferred revenue. This liability reflects the money received from customers for goods or services not yet delivered.
• Most common Non-Current Liabilities:
oLong-term Loans, Mortgages. Amounts due for borrowings with maturities longer than one year. They are interest-bearing obligations.
oPension 养老金 Obligations. Obligations with employees, payable when they retire.
oRestructuring provisions, Litigation provisions. 重组条款，诉讼条款。These are obligations of the firm for losses incurred but not yet paid as a result of restructuring plans:重组计划产生的
oThe closing of certain lines of business
oThe elimination of redundant employees, etc. Also lawsuits that the company expects to lose with certainty.
oCapital lease obligations. These are the amounts owed for the right to use leased assets during periods longer than one year. 租赁资产
oDeferred tax liabilities. Income taxes payable in the future as a result of temporary taxable differences.
• Most common Owners’ Equity Accounts:
üShareholders’ equity is the value of a business to its owners after all of its obligations have been met. This net worth belongs to the owners. It reflects the amount of capital the owners have invested, plus the profits generated that were subsequently invested in the company.
oShare capital or Common stock. The par or nominal value of the ordinary shares multiplied by the number of shares issued. 股本或普通股票。普通股的面值或名义价值乘以发行的股份数量。
oShare premium or Additional paid in capital. Price of issued in excess of their nominal value. 股票溢价或额外的实收资本。超过其名义价值的发行价格。
oPreferred shares. These are shares different from the common shares that have different voting and / or dividend.o优先股。这些股份与普通股不同，具有不同的投票权和/或股息。
oRetained earnings. Profits of the current and past periods that have been retained in the firm and not distributed to owners. (if negative, accumulated losses).留存收益。当期和过去各期的利润，这些利润被保留在公司中，没有分配给所有者。(如果是负数，则为累积亏损）。
• Accumulated other comprehensive income. This is accumulation of gains (or losses) that affect the wealth of the owners but that are still not recognized in retained earnings
ØExample: An increase in value of certain financial asset during a period. The owners are richer and must recognise a gain. However, accounting rules call for this unrealized gain (since the asset has not been sold) to be excluded from current earnings. Instead the gain is taken directly to accumulated other comprehensive income (also called Reserves in Europe).
qMany legislations require creation of a legal reserve fund, as a percentage of profits.
qOther types are general reserves and specific reserves (are set aside for a specific purpose and cannot be used for any other reason).
oNon controlling interest. Equity interests of minority shareholders in firms controlled by the reporting company. They represent the claims of the minority shareholders on the consolidated assets and liabilities. They only appear in consolidated balance sheets.
Ø举例说明。某一时期某些金融资产的价值增加。业主变得更富有，必须确认收益。然而，会计规则要求这个未实现的收益（因为该资产没有被出售）不包括在当期收益中。相反，该收益被直接计入累积的其他综合收益（在欧洲也被称为储备金）。
q许多立法要求建立一个法定的储备基金，作为利润的一个百分比。
q其他类型有一般储备金和特定储备金（为特定目的而留出，不能用于任何其他原因）。
o非控制性权益。由报告公司控制的公司的少数股东的股权。它们代表了少数股东对合并资产和负债的要求。它们只出现在合并资产负债表中。
• Approach to the analysis of financial statements:
üPurpose of the analysis
üFirst, the big picture !
üBalances in percentages (Total Assets = Total equity and liabilities = 100%)
üRatios
üList of loans ordered by expiration date, costs and guarantees given.
- Balance Sheet is important, but it is not enough. It is necessary to analyse the income statement, the cash flow statement and the notes to financial statements.
- We will use Indicators to compare different periods, also to compare similar companies vs. the average of companies within the same industry.
