The balance sheet statement is one of 3 main financial statements (Income statement, Balance Sheet Statement and Cashflow statement). The Balance Sheet is unique as it shows only the assets and liabilities of a company.
Assets for examples are the factories it owns to make phones and liabilities for example are debt in which it needs to pay back at a later date.
All assets and liabilities are valued at the market selling price or known as “mark to market”. Hence, the balance sheet shows exactly how much assets and liability a company has in a moment in time.
The balance sheet is also unique in the sense that it follows a simple equation which is
Share holder Equity = Total Assets – Total Liability
This simply means when you sell of all of the company’s assets and pay back all of the liabilities and whatever is left belong to shareholders. So, Assets – Liabilities should equal shareholders equity. If this equation does not balance, then the balance sheet is wrong!
Examples
Amazon
Starbucks
The Layout of a balance sheet is as follows.
Total Assets
Current Assets (Takes less than 12 months to turn into cash)
Cash & Cash equivalent – This is actual cash at the bank and also highly liquid market instrument which can be converted into cash very quickly. There is a slight disagreement by analyst and accountants by what is actually meant when we say “can be quickly converted into cash” but usually CD (Credit deposit) which can be converted into cash within 24 hours or so can be counted as cash. However, some might even extend the duration up to 2 to 3 days so there are some degree of subjectivity which for the purpose of understanding a Balance sheet we are not going to get into.
Accounts Receivable – This is an IOU’s which other companies owes you and will collect soon. This arise when you deliver the goods and services, but the client has yet to pay, but will soon. The duration of course is that this will be collected within 12 months and is usually collected within 90 days.
Inventory – We assume inventory e.g. iPhone or cloths can be sold within 12 months and converted into cash and hence why inventory is under current assets.
Pre-Paid Expense – These are expenses which have been prepaid for long period into the future, but the benefit will only get recognized at the point of consumption. Essentially, you can think of this as car insurance when you pay for 12 months cover upfront e.g. in January, but you will receive insurance coverage up until December but the cost has already been paid in January. However, because in accounting the benefit will get recognised on a month-by-month basis, the remainder will be stored in pre-paid expense.
Non-current Assets (Takes longer than 12 months to turn into cash)
Plant Property & Equipment (PP&E) -This is factories, production machine, vans… etc anything which will take longer then 12 months to sell and convert into cash. Its also important to note that this line item is normally associated with depreciation as the value of machinery drops over time to represent the wear and tear the drop in value is represented as depreciation which is tax deductible and hence how this line item is connected to the income statement as well as the cashflow statement.
Goodwill – This is where the pure accounting and investment banking/ financial modelling slightly diverges. From the perspective of pure accounting the lien item Goodwill is usually similar to Intangible assets e.g. Patterns, Intellectual Property, Brand, Reputations… However, for the purpose of financial modelling in investment banking the line-item Goodwill is where you would account for M&A activity which is beyond book value. If company A buy company B and pays $100m but with a book value of only $80m, then that excess $20m is considered as Goodwill. That was a simplistic example to illustrate the point.
Intangible – This is intangible assets e.g. Patterns, Intellectual Property, Brand, Reputations. Just like PP&E which has depreciation, intangibles also depreciate in value over time, but it’s known as amortization which is also located on the income statement.
Total Liability
Current Liability (Takes less than 12 months to turn into cash)
Accounts Payable – This is the reverse of Accounts Receivable (AR). In this case we owe other companies’ money and since its due in less then 12 month its it a current liability.
Short term Debt – This is short term debt which is due within 12 months.
Revolver – A revolver is like a corporate credit card which gives companies quick access to cash but as a very high interest rate. This is also considered as short-term debt which must usually be paid back within 12 months and is hence a current liability.
Accrued Liability – these are outflows of cash which the company has yet to pay but already received the benefit of the goods or service. For example, it’s the middle of the month so the company has benefited from all the staff working since the start of the month without paying out any salary because its only at the end of the month that every staff gets paid in full even though they each delivered their labour from the start of the month.
Non-current Liability (Takes longer than 12 months to turn into cash)
Long term Debt – This is simple, its long-term debt which has to be paid over a long period of time (longer then 12 months hence the non-current liability). Think of this like a mortgage which has to be repaid over a long period of time.
Deferred Taxes – these are taxes the company has to pay but due to accounting treatment (strait line depreciation vs acceleration depreciation) has cause a temporary disturbance in the timing of the payment. Essentially, the amount due to the tax authorities will be still be paid in full but in this case the company has not paid all that was due in and has to make up for that extra amount later on in the next time period and hence why it is a liability for the company.
Total Shareholder Equity
Stock Value at Par + Paid in Capital (PIC) – This line item measures the value of the company’s stock that the company owns, hence stock value at par. When a company has excess cash and wants to raise its own share price they would buy their own stock on the open market to reduce the shares outstanding on the open market which will benefit investors with higher share price. Alternatively, if the company wants to raise cash, then they would sell their own shares which they own on the open market to investors. Paid in Capital or “PIC” is the amount of money which equity investors has poured into the company.
Retained Earnings – this line item captures Net Income form the income statement less dividends paid out to equity investors. This is essentially the net profit which the company will keep and management will decide how to use this, be it for paying down debt, fund growth, buying back shares on the open market, M&A activity or fund Research and Development…etc There are various ways which this will be used.
Total Shareholder Equity
Once you sell off all of the company’s assets and pay of the liability then whatever is left belong to the equity shareholders (not all shareholders are equity owners).
Take a look at the income statement and cashflow statement to see how all 3 financial statements interlink.
Take a look at the financial modelling course where we take you step-by-step into building and forecasting the three financial statement and build a full financial model in excel. Also, get actual interview answers needed to ace the interviews and truly stand out as one of the better prepared candidates instantly.
