Balance Sheet Basics
Balance Sheet is the snap shot of financial strength of any company at any point of time. It gives the details of the assets and the liabilities of the company. Understanding balance sheet is very important because it gives an idea of the financial strength of the company at any given point of time. Following is the balance sheet of Global Telesystems for the year ending on 31st Mar’ 2000:
|Other Current Assets||3673.67|
|Balance Sheet Total||9142.92|
|Equity Share Capital||434.12|
|Creditors and Acceptances||393.91|
|Other current liab/prov.||402.55|
|Balance Sheet Total||9142.92|
Let us take a look at each of its components.
Gross block is the sum total of all assets of the company valued at their cost of acquisition. This is inclusive of the depreciation that is to be charged on each asset. Net block is the gross block less accumulated depreciation on assets. Net block is actually what the asset are worth to the company.
Capital work in progress, sometimes at the end of the financial year, there is some construction or installation going on in the company, which is not complete, such installation is recorded in the books as capital work in progress because it is asset for the business.
If the company has made some investments out of its free cash, it is recorded under the head investments. Inventory is the stock of goods that a company has at any point of time. Receivables include the debtors of the company, i.e., it includes all those accounts which are to give money back to the company. Other current assets include all the assets, which can be converted into cash within a very short period of time like cash in bank etc.
Equity Share capital is the owner’s equity. It is the most permanent source of finance for the company. Reserves include the free reserves of the company which are built out of the genuine profits of the company. Together they are known as net worth of the company.
Total debt includes the long term and the short debt of the company. Long term is for a longer duration, usually for a period more than 3 years like debentures. Short term debt is for a lesser duration, usually for less than a year like bank finance for working capital.
Creditors are those entities to which the company owes money. Other liabilities and provisions include all the liabilities that do not fall under any of the above heads and various provisions made.
Role of Balance Sheet in Investment Decision making
After analyzing the income statement, move on to the balance sheet and continue your analysis. While the income statement recaps three months’ worth of operations, the balance sheet is a snapshot of what the company’s finances look like only on the last day of the quarter. (It’s much like if you took every statement you received from every financial institution you have dealings with — banks, brokerages, credit card issuers, mortgage banks, etc. — and listed the closing balances of each account.)
When reviewing the balance sheet, keep an eye on inventories and accounts receivable. If inventories are growing too quickly, perhaps some of it is outdated or obsolete. If the accounts receivable are growing faster than sales, then it might indicate a problem, such as lax credit policies or poor internal controls. Finally, take a look at the liability side of the balance sheet. Look at both long-term and short-term debt. Have they increased? If so, why? How about accounts payable?
After you’ve done the numerical analysis, read the comments made by management. They should have addressed anything that looked unusual, such as a large increase in inventory. Management will also usually make some statements about the future prospects of business. These comments are only the opinion of management, so use them as such.
When all is said and done, you’ll probably have some new thoughts and ideas on your investments. By all means, write them down. Use your new benchmark as a basis for analyzing your portfolio next time. Spending a few minutes like this each quarter reviewing your holdings can help you stay on track with your investment goals.