Balance Sheet
a.k.a. Statement of Financial
Position
Elements in the Balance Sheet
• Assets
• Liabilities
• Owners’ Equity
• Shown at a point in time
– A single transaction changes it!
Classification of Assets
• Current Assets
– Converted or consumed within a year
– Listed in order of liquidity
– Examples
• Cash
• Marketable securities
• Accounts receivable
• Inventory
• Prepaids
• Long-term Investments
– Available for sale securities
– Held to maturity securities
– Equity investments in affiliates
Classification of Assets
• Property, Plant, & Equipment
– A.k.a. plant assets or fixed assets
– Long life
– Physical nature
– All except land are depreciated
– Land can be a long-term investment
• Intangible assets
– No physical substance
– Rights-related assets are amortized
– Goodwill is assessed for impairment
Classification of Liabilities
• Current liabilities
– To be paid within next year
– To be paid with current assets
– Includes current portion of longer term
debt
– Also includes unearned revenues
– Current Assets – Current Liabilities =
Working Capital
• Long-term liabilities
Stockholders’ Equity
• Contributed capital
– Stock
– Additional paid in capital
• Retained earnings
• Treasury stock
• Accumulated comprehensive income
Usefulness of Balance Sheet
• Assess liquidity
• Assess solvency
• Riskiness
Limitations
• Historical cost
• Judgments and estimates
• Unreported items
– Off balance sheet financing
• Complex items
Common Analysis Tools
• Current ratio
• Acid-test (or Quick) ratio
• Vertical analysis
• Debt to assets ratio
• Debt to equity ratio
• Accounts receivable turnover
• Inventory turnover
• Times interest earned
Altman’s Z-score
• Excellent predictor of bankruptcy
• Function of the following ratios
– WC as % of assets
– RE as % of assets
– ROA
– Sales / Assets
– Equity / Liabilities
Disclosures
• Contingencies
– Probability
– Estimability
• Accounting policies
• Contractual obligations /
Commitments
• Details of various line items
– Supporting schedules
– Explanations
Statement of Cash Flows
Sections in the SCF
• Operating activities
– Results of operations
– Indirect format starts with net income
– Adjust for non-cash line items
– Adjust for changes in current accounts
that reflect accrual
• Investing activities
– Purchases and sales of long-term assets
• Financing activities
– Borrowing and repaying long term debt
– Stock related transactions and dividends
Summary of SCF
Cash flow from operations
± cash flow from investing
± cash flow from financing
= net cash flow
Add beginning balance in cash
Should give ending balance in cash
Usefulness of SCF
• Determine quality of earnings
• Assess investment behavior
• Links the income statement to
changes in the balance sheet
Adjustments made in the
operating activities section
• Any non-cash expenses, gains, and
losses need to be undone
– Add back in depreciation, amortization,
or depletion expenses
– Add back any losses that were
subtracted
– Subtract out any gains that were added
• Gains and losses will be reflected in
investing activities cash flows
Changes related to current assets
• If accounts receivable goes up, then some
sales were not collected in cash
• Therefore, subtract that change from net
income to get cash flow
• If there are prepaid expenses, some
expenses on the income statement must
have been paid in a previous period
• If those prepaids go down, expenses on
the IS are more than what you paid for this
year
• Therefore, add that change back to net
income to get cash flow
• Common thread: changes in current
assets result in inverse adjustments