Balance sheets speak volumes, telling investors about the health of a company and how efficiently management runs the business. Moreover, they provide the necessary inputs used to calculate certain line items on the income statement. For instance, calculating cost of goods sold requires the level of inventory (raw materials, work in progress), which is found under “assets” on the balance sheet. In combination with the income statement, the balance sheet can also provide insights into the returns the company produces. The simplest way to make sense of a balance sheet is to calculate and analyze financial ratios. But ratios alone do not reveal the strength of a balance sheet. The real information comes from following the trend and comparing the ratios to industry competitors. Let’s examine Google's (GOOG) 2014 year-end balance sheet to ascertain its financial and management strength.

Liquidity Ratios

Analysts use two common liquidity ratios, quick ratio and current ratio, to understand a company’s ability to pay its liabilities. Google’s liquidity ratios are as follows:

 2014 2013 Liquidity Ratios Quick Ratio 3.83 3.69 Current Ratio 4.80 4.58

Interpretation: The higher the ratio, the better, meaning that Google is able to cover its current liabilities with its current assets. Current assets are assets that can be changed into cash quickly, such as cash, marketable securities, and accounts receivables. For example, 2014’s current ratio means that for every \$1 of current liability, Google has \$4.8 of current assets, indicating that the company's overall liquidity is very good.

Efficiency Ratios

These ratios indicate how well a company uses its assets and liabilities, such as how long it takes to receive payments from customers, how long it takes the company to pay its bills, and how well it converts its fixed assets into sales revenue. Google’s efficiency ratios are as follows:

 2014 2013 Efficiency Ratios Receivable Turnover 6.86 7.09 Fixed Asset Turnover 3.27 4.22 Sales to Net Working Capital 7.73 9.16 AP to Sales 0.03 0.04 Days Sales Outstanding (DSO) 56.73 54.80 Days Payables Outstanding (DPO) 24.37 40.71 Intangibles % of BV 0.04 0.07

Interpretation: The higher the receivable and fixed asset turnover ratios, the better. Google is turning its receivables into cash. In 2014, the company collected its receivables almost seven times per year, slightly slower than the prior year, but still at a good pace. A higher fixed asset ratio is also preferable. It indicates Google is generating \$3.27 in sales for every \$1 invested in fixed assets. This ratio has also slightly decreased from 2013. Likewise, sales to net working capital also declined from 2013. In 2014, Google generated \$7.73 for every \$1 invested in working capital.  Conversely, lower accounts payable (AP) to sales, days sales outstanding (DSO), and days payable outstanding (DPO) indicate higher efficiency. While DSO were slightly worse in 2014, DPOs were greatly improved from 2013, which is a higher quality metric indicating that the company is paying its bills. Sometimes companies will increase "cash" by increasing payables, making assets look artificially higher. Intangibles are less than a percent of Google's book value. This calculation excludes goodwill which cannot be sold, but includes Google’s technology patents which are a critical component of its operating business. Overall efficiency is slightly lower than 2013 but still strong.

Strength and Profitability Ratios

Solvency or leverage ratios are important measures of the level of assets generated internally (equity) versus provided by others in the form of debt. Also, profitability or management strength is measured by return on equity or asset ratios. Key ratios for Google are:

 2014 2013 Strength Ratios Debt-to-Equity 5.0% 6.0% Deb-to-Assets 4.0% 4.7% Profitability Ratios Return on Equity 15% 14% Return on Assets 12% 14%

Interpretation: The lower the debt-to-equity or assets, the better. These ratios indicate Google uses a lower proportion of debt than equity or assets to finance its assets, and the trend here is favorable (better in 2014 than 2013). Profitability ratios are used to measure the management strength or how well the company can generate a profit from the equity or assets employed. The higher the return, the more preferable. Return on equity (ROE) was marginally more favorable in 2014 for Google, while the return on assets (ROA) was slightly less. Overall, balance sheet and management strength improved in 2014.

Balance Sheet-Based Valuation

Deciding whether to buy or sell shares of GOOG is also influenced by its valuation. Common valuation multiples include price to earnings (P/E) or enterprise value to EBITDA (EV/EBITDA)--

inputs that come from the income statement. The balance sheet also adds insights into the attractiveness of a stock, particularly based on cash and book value and how it changes over time.

 2014 2013 Valuation cash/share 93.72 86.65 BV /share 152.10 128.85

Interpretation: Cash value per share in essence tells the investor that even without any profits, Google is able to invest in itself at the rate of \$93 per share. The book value per share of \$152 shows that at the end of 2014, Google was trading about 3.5 times its per share book value.

Industry Comparisons

In addition to trend analysis, competitive analysis is useful to determine if the company’s balance sheet is within a normal range for its industry. Any deviation from the pack warrants further analysis to understand why the ratios differ so dramatically. Trailing twelve-month (TTM) ROE and ROA and most recent quarter (mrq) debt-to-equity ratio (D/E) and current assets (CA) ratios are common ratios to assess balance sheet strength against peers. Compared to Internet content peers Yahoo, Inc. (YHOO) and Facebook, Inc. (FB), Google’s balance sheet appears in the middle of the pack.

 Industry Comps Yahoo (YHOO) Facebook (FB) Google (GOOG) ROA (TTM) 0.38 10.72 8.71 ROE (TTM) 29.02 11.4 14.52 D/E (mrq) 3.14 0.65 7.67 CA (mrq) 2.14 9.6 4.8

Source: Yahoo Finance.

Interpretation: Google is significantly better at generating a profit from its assets than Yahoo and only slightly behind Facebook. Google's ROE is better than Facebook's, but it pales in comparison to Yahoo's. Some of the variation might come from Yahoo’s shareholder equity account, which might be considerably lower. In terms of liquidity and solvency, Google has a higher debt-to-equity ratio than its peers, but it is able to cover its current liabilities using its current assets at 4.8:1. Overall, this comparison shows that Google’s balance sheet appears within the industry standards.

Warnings

Be warned: the balance sheet is a place company’s might try to hide expenses or make other financial maneuverings to manipulate current earnings. Capitalizing costs that should be expensed, pre-paid expenses that increase assets, and accrued expenses that increase liabilities should run through the cost on the income statement, which would reduce net income. A large bump up in these year-over-year is a red flag. There are many other accounting gimmicks that can boost earnings, such as the use of off balance sheet arrangements. Google’s prepaid assets and accruals are in line from 2013 to 2014, indicating the company uses consistent accounting for these items.

The Bottom Line

Final analysis reveals that Google appears to have a solid balance sheet. High liquidity, slightly lower efficiency, improved management strength, and higher valuation compared to 2013 show that Google’s balance sheet is strong. Finally, Google is well-positioned compared to industry competitors.

Disclaimer: The author owns shares in Google, Inc.

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