Understanding financial statements — the balance sheetWednesday, August 04, 2021
By Toni-Ann Myrie
A picture is worth a thousand words, but financial statements tell a thousand stories. When analysing the performance of companies you've invested in, it's important to look at the financial statements.
The financial statements of a company capture its overall performance, how and what it uses money for, and what the business owns and owes. There are three financial statements that bankers, investors, shareholders and other interested parties always look to when they want to get information — the profit and loss statement, the balance sheet and the cash flow statement.
A balance sheet is a statement that sets out a company's assets, liabilities and capital.
An asset is a resource that a company owns with the hope that it will help to make some money in the future. The balance sheet is divided into three sections: assets, capital and liabilities. The listing of the company's assets is usually in the first half of the balance sheet.
A company's assets are divided into categories; the three main ones are intangible assets, fixed or long-term assets and current or short-term assets.
Intangible assets, as the name suggests, are resources that you cannot see or touch. These include things such as trademarks, copyrights, and goodwill.
Goodwill is the value the company's customers place on the company. While some companies include intangible assets on their balance sheet, one such being Seprod Limited, many choose not to because it is difficult to calculate a value for intangible assets.
For example, the balance sheet for Lasco Manufacturing may say that the company has assets valued at one billion Jamaican dollars but to us, Lasco has so much more value because of the memories we've attached to using Lasco products. You may have been using Lasco milk powder since you were a baby and still use it today to make drink mixes or cereal. You would be devastated if Lasco was to stop producing Lasco milk powder. That is Lasco's goodwill, but how much is that actually worth in dollars? That's where it gets tricky.
The next category is fixed assets. These usually include plants, equipment, buildings, and motor vehicles. They are called fixed assets because they usually serve companies for a long while and are fixed, or not easy to move. At the end of each financial year accountants calculate the value of the assets, taking into consideration wear and tear, and then report the value on the balance sheets.
Current or short-term assets are assets that do not last long. These include inventory, receivables, investments and cash. Inventory can be further broken down into finished goods, work in progress or raw materials. The inventory amount that is reported on the balance sheet is the inventory that remains on the last day of the company's financial year.
Receivables is money that the company is yet to collect from its clients for goods or services that have been supplied to them. Investments include things such as stocks, bonds and fixed deposits.
And lastly, cash is simply the amount of money that they physically store at the business and keep in their bank accounts.
The first half of the balance sheet is set out like this because the assets are usually listed according to their liquidity.
Liquidity means how fast these assets can be converted into cash. The assets that take the longest to be sold, such as property and equipment, are listed first.
The most liquid asset, cash, is listed last. In that case, property, plant, and equipment are listed first because they may take many years to sell, then motor vehicles which take a couple months. Then come current assets. Inventory may be able to be sold within weeks while receivables may take some time to collect, but not a long time. Investments can be sold off within a couple days to get cash and lastly, there is cash. Cash is the most liquid. Companies can just take the cash they have and use it to pay their creditors or employees instantly.
The balance sheet can be represented using the following equation:
Assets equal capital plus liabilities: A = C + L
Basically, the company owns assets but it has to use money from shareholders, as well as loans, to purchase those assets.
In part two we'll look at the second half of this equation — capital and liabilities.
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