Understanding Balance Sheets Flashcards
Balance sheet reports the firms financial position at a point in time. Consists of assets, liabilities, and equity
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Assets
= resources controlled as a result of past transactions that are expected to provide future economic benefits
Liabilities
= obligations because of a past event that requires an outflow of economic resources.
Equity
= owners’ residual interest in the assets after deducting the liabilities
Liquidity
the ability to meet ST obligations
Solvency
ability to meet LT obligations
The are numerous valuations per balance sheet
some historical, some amortized or present value
Classified balance sheet
separately report current and noncurrent assets. IFRS and GAAP required.
Liquidity based format
present assets and liabilities in order of liquidity. Often in banking industry.
- IFRS allows this format if it makes more sense for the business to calculate balance sheet as such.
Current assets
cash and other assets that will likely be converted to cash within one year or operating cycle. Presented in order of greatest liquidity.
Current liabilities
obligations that need to be met within 1 year or operating cycle.
If it meets any of the following criteria:
- settlement expected in operating cycle
- settlement expected in 1 year
- held primarily for trading purposed
- not an unconditional right to defer settlement
Working capital
= current assets - current liabilities
- If WC is high = inefficient use of WC
if WC is low = not enough liquidity
If assets are not current, they are noncurrent assets.
Noncurrent assets shows indicators of the firms’ investing activities
If liabilities are not current, they are noncurrent liabilities.
They highlight the long term financing activities of the firm.
Current Assets examples:
- Cash and cash equivalents (MMF, Treasury bills @ fair value)
- Marketable securities (Treasury bills, notes, bonds and equity securities)
- Accounts Receivable: assets owed to firm from consumers on credit. Reveals collection problems.
- Inventories: separate from raw materials, works in process. Standard costing to measure inventory, which assigns predetermined amounts of materials labor and overhead to produced goods
- Other: prepaid expenses and deferred taxes
Current Liabilities Examples
- Accounts Payable: amounts owed to suppliers that are on credit.
- Notes payable: obligations in the form of promissory notes owed to creditors and lenders. (if maturity > 1 year, it is a noncurrent liability)
- Accrued liabilities: expenses that are recognized in income statement but are not yet contractually due.
- Unearned Revenue: cash collected in advance for providing goods/services.
Noncurrent Assets Examples
- Property, Plant and Equipment (PP&E): “ and tangible assets used in production of goods and services. Measured by cost model. (IFRS allows revaluation model).
- Investment Property: rental income or capital appreciation. Amortized cost or fair value model.
- Intangible Assets: non-monetary assets that lack physical substance. Measured by the cost model. (IFRS allows reevaluation.)
- Goodwill: the excess purchase price over the fair value of the identifiable net assets acquired in a business acquisition.
- Financial Assets: Investment securities, derivatives, loans and receivables. Measured by historical cost(loans and receivables), amortization or fair value(trading securities and derivatives).
Cost model
PPE, other than land, is amortized
Impaired Asset
when its carrying value exceeds recoverable amount
Fair Value Model
Any change in fair value recognized in income statement.
Through goodwill, firms can manipulate net income by allocating more acquisition price to goodwill and less identifiable assets, resulting in less depreciation and amortization expense.
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Held-to-market securities
Debt securities acquired to hold to maturity
Non-current Liabilities Examples
- LT financial liabilities: banks loans, notes payable, bonds payable, and derivatives. Usually amortized, sometimes fair value.
- Deferred tax liabilities: amounts of income taxes payable in future periods as a result of taxable temporary differences.
Owners’ Equity
- the residual interest in assets that remains after subtracting an entity’s liabilities.
- Including: contributed capital, par value of common stock, preferred stock, retained earnings.
Common size balance sheets
Expresses each item of the balance sheet as a percentage of total assets.
- eliminates the effect of size, allowing comparison by time-series and cross sectional.
Current ratio
Current Assets / Current Liabilities
Quick ratio
(Cash + marketable securities + Receivables) / Current Liabilities
Cash ratio
(Cash + marketable securities) / Current Liabilities
LT debt-to-equity
LT debt / total equity
Total debt-to-equity
total debt / total equity
debt ratio
total debt / total assets
Financial leverage
total assets / total equity
