Quantitative Methods of Evaluating Businesses and Investments - Balance Sheet

The Balance Sheet
The balance sheet is simply a picture of a company's assets and liabilities at a specific point in time. It is similar to a net worth statement for an individual, except that the "net worth" is referred to as "shareholders' equity."

For a business, the following formula applies:


Shareholders\' Equity = Total Assets - Total Liabilities


Assets fall into three categories:

  • Current - includes cash, marketable securities, accounts receivable and inventories

  • Fixed - refers to items owned and used by the company, such as real estate, equipment and furniture. The value used on the balance sheet is the original cost minus depreciation taken in previous years.

  • Intangibles- these are the non-physical components of the business's value, such as patents, copyrights, trademarks, franchises and goodwill.

Liabilities are defined as either current or long term.

  • Current liabilities - amounts that must be paid within a year and include:
    • Accounts payable
    • Notes payable
    • Taxes payable
    • Interest payable
    • Dividends payable

  • Long-term liabilities - amounts that become payable more than one year into the future and generally includebonds and long-term bank loans.

The key calculation derived from a company's balance sheet is working capital, which is obtained by subtracting current liabilities from current assets:


Working Capital = Current Assets - Current Liabilities



Look Out!
Working capital is not affected when a company buys securities with cash, since current assets include both cash and securities. A typical exam question will offer that scenario and then ask which balance sheet items are affected. Working capital will be an incorrect answer.


Shareholders' Equity
includes three components:

  • Common and preferred stock - on the balance sheet, only the par value of both classes of stock is used, not the market value. (Par value is a dollar amount assigned to a security when first issued. For stocks, par value usually is a small amount that bears no relationship to its market price.) This par value is multiplied by the number of outstanding shares.

  • Capital surplus- this refers to the premium that shareholders pay in excess of the par value, usually when stock is issued by a company. Also called paid-in surplus.

  • Retained earnings - these are the net profits the company retains for future use rather than pay out as dividends.


Exam Tips and Tricks
You can expect only one or two questions on financial
statements, such as:

XYZ Corporation buys furniture for a new addition onto its headquarters. Which of these items on its balance sheet will be affected?

Current Assets

  • Current Liabilities
  • Net Worth
  • Working Capital
    1. I and III
    2. I and IV
    3. II and III
    4. All of the above


    The correct answer is "b", since cash (a current asset) will decrease, this also decreases working capital. Furthermore, furniture is a fixed asset, not a current asset; and net worth is only affected by profit, loss or dividend payout.

    Time Value of Money


    Related Articles
    1. Investing Basics

      Reading The Balance Sheet

      Learn about the components of the statement of financial position and how they relate to each other.
    2. Fundamental Analysis

      Reviewing Liabilities On The Balance Sheet

      As an experienced or new analyst, liabilities tell a deep story of how a company finances, plans and accounts for money it will need to pay at a future date.
    3. Markets

      Fundamental Analysis: The Balance Sheet

      By Ben McClureInvestors often overlook the balance sheet. Assets and liabilities aren't nearly as sexy as revenue and earnings. While earnings are important, they don't tell the whole story. ...
    4. Investing

      Current Liabilities

      Current Liabilities are company debts due within one year or one operating cycle, whichever is greater. An operating cycle is the time it takes a company to purchase inventory and convert it ...
    5. Economics

      Understanding Total Liabilities

      Total liabilities are the combined debts an individual or company owes.
    6. Stock Analysis

      How To Read Apple's Balance Sheet

      We explain how to find, read, and analyze a balance sheet from Apple.
    7. Investing

      What's a Liability?

      A liability is a debt. It is an obligation that arises during the course of business and represents a third-party claim on the company's assets. A liability can arise in a number of different ...
    8. Budgeting

      Evaluating Your Personal Financial Statement

      Determine your net worth by making your own cash flow statement and balance sheet.
    9. Investing

      Ben Graham's Advice on Reading Financial Statements

      Seven pieces of advice from Benjamin Graham on understanding financial statements.
    10. Investing Basics

      How To Evaluate A Company's Balance Sheet

      Asset performance shows how what a company owes and owns affects its investment quality.
    RELATED TERMS
    1. Balance Sheet

      A financial statement that summarizes a company's assets, liabilities ...
    2. Current Liabilities

      A company's debts or obligations that are due within one year. ...
    3. Other Current Liabilities

      A balance sheet entry used by companies to group together current ...
    4. Shareholders' Equity

      A firm's total assets minus its total liabilities. Equivalently, ...
    5. Total Liabilities

      The aggregate of all debts an individual or company is liable ...
    6. Other Long-Term Liabilities

      A balance sheet item that includes obligations which are not ...
    RELATED FAQS
    1. How are accounts payable listed on a company's balance sheet?

      Find out how accounts payable is listed on a company's balance sheet, why it is considered a current liability, and how it ... Read Answer >>
    2. Does the balance sheet always balance?

      Yes, a balance sheet should always balance. The name "balance sheet" is based on the fact that assets will equal liabilities ... Read Answer >>
    3. Do dividends go on the balance sheet?

      Learn about dividends and which accounts on a company's balance sheet they affect, such as cash, shareholders' equity and ... Read Answer >>
    4. What is the difference between a fixed asset and a current asset?

      Discover the difference between fixed assets and current assets and the value of each to a company. Learn the category and ... Read Answer >>
    5. On which financial statements does a company report its long-term debt?

      Discover which financial statements are used to report a company’s long-term debt, as well as how a company uses debt to ... Read Answer >>
    6. What is the difference between an expense and a liability?

      Learn what liabilities and expenses are, which financial statements they are listed on, and the differences between liabilities ... Read Answer >>
    Hot Definitions
    1. Goldilocks Economy

      An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
    2. White Squire

      Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
    3. MACD Technical Indicator

      Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
    4. Over-The-Counter - OTC

      Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
    5. Quarter - Q1, Q2, Q3, Q4

      A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
    6. Weighted Average Cost Of Capital - WACC

      Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
    Trading Center