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Balance Sheet Basics
A Balance Sheet indicates the financial strength of the company at a given point of time. It is a snap-shot of what a company owns and owes. i.e., it gives the details of the ‘Assets’ and ‘Liabilities’. The following section describes the important elements of the Balance Sheet.
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Format of a Balance Sheet |
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Assets |
Amt. |
Liabilities |
Amt. |
|
Non-Current Assets |
X,XXX |
Shareholders funds a. Share Capital b. Reserves & Surplus |
X,XXX |
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Investments |
X,XXX |
Non-Current Liabilities |
X,XXX |
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Current Assets |
X,XXX |
Current Liabilities |
X,XXX |
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Total Assets |
X,XXX |
Total Liabilities |
X,XXX |
Assets
Assets are resources which are expected to provide a firm with future economic benefits. An item can be recognized as an asset if the firm has acquired rights over it or can quantify future economic benefits that can be derived from that item with a fair degree of accuracy. Non-Current Assets: These are assets which are expected to produce benefits for more than a year. These are classified as tangible and intangible assets. Tangible non-current assets include land, building, plants and machinery and are reported at net book value (Cost price less accumulated depreciation). Intangible non-current assets include items such as patents, copyrights, trademarks and goodwill and are also reported at net book value, (Gross value less accumulated amortization). Amortization is the allocation of the cost of the intangible asset over the accounting period that benefits from its use. Investments: These are generally made up of financial securities like, shares and debentures of other companies, most of which are likely to be associate and subsidiary companies. These investments are made primarily to generate income from idle cash. Investments made for short-term purposes are recorded under current assets and are carried at cost or market value, whichever is lower. Long-term investments are valued at cost less any decreases in value which is regarded as permanent. {mospagebreak} Current Assets: This consists of cash and other assets which are expected to be converted into cash during the next operating cycle of the firm. The major components of current assets are Cash, Receivables, Inventories and Prepaid expenses. While a large amount of current assets may give an impression of good liquidity, it is important to know tht structure of the current assets. Large amounts of inventory indicate slow moving obsolete products or new products which are expected to be sold next year. Similarly, large amounts of receivables might give a false impression of liquidity if the company has poor collection efforts. Liabilities
Liabilities are debts and obligations that arise during the course of business operations. This section of the balance sheet also forms a crucial part as it describes the various financing decisions taken by the management to fund the business operations. The following section describes some of the important components of the liabilities section of the balance sheet. Shareholders funds: Shareholder’s equity is also referred as Owners’ or Stockholders’ equity. It includes the contribution made by shareholders to the company and retained earnings that the company accumulates overtime through its operations. Reserves and surplus are comprised of retained earning, share premium and capital subsidy. Reserves are held in two forms, capital reserves and revenue reserves. Capital reserves cannot be distributed as dividends to shareholders and include items like share premium, revaluation reserve and capital redemption reserve. Revenue reserves are the accumulated retained earnings held in the form of investment allowance reserves, dividend equalisation reserves, taxation reserves and general reserves. Non-Current Liabilities: Non-current liabilities are the obligations with maturities greater than one year. These include secured loans such as, debentures, term loans, working capital loans and unsecured loans such as inter-corporate loans and public deposits. Companies carrying large amount of such long-term liabilities are riskier from the creditor’s point of view since these companies can find themselves overburdened with interest payments during a slow business cycle. The important ratios used by creditors to judge a company’s ability to repay the amount of liabilities it carries are the debt service coverage ratio, the interest coverage ratio and the cash flow coverage ratio. {mospagebreak}
Current Liabilities: Current liabilities represent obligations, (debts), that are expected to mature in the next operating cycle. The most common items included are accounts payable, sundry creditors, advanced payments and interest accrued. They also include provisions made for obligations that are expected to mature next year such as provisions for taxes, dividends and provident funds. Key items to be considered while analysing the ‘Balance Sheet’: A balance sheet is a very crucial statement to evaluate the credit worthiness and the liquidity position of a company. A novice investor should consider the following points while analysing a balance sheet. The debt to equity ratio can be used to judge the risk of investing in a business. Companies often choose debt as it is a cheaper source of financing, however, the greater the debt to equity ratio, the greater the risk to creditors. The asset turnover ratio is used to measure the efficiency of the assets employed by a company. The turnover ratio needs to be considered along with the corresponding proportion of depreciation assigned to the assets. Because, the value of assets might tend to be low if they are old and substantially depreciated.