The balance sheet is a snapshot on one date. It always satisfies the accounting equation:
Assets are resources the company controls. Liabilities are obligations it owes. Equity is the residual claim of the owners. The equation holds because every asset was financed either by borrowing or by owners.
Current assets are expected to turn into cash within 12 months: cash and equivalents, short-term investments, accounts receivable (amounts customers owe), inventory, and prepaid expenses. Non-current assets last longer: property, plant and equipment (PP&E) shown net of accumulated depreciation; right-of-use assets from leases; intangible assets such as patents and software; goodwill; long-term investments; and deferred tax assets.
Current liabilities fall due within 12 months: accounts payable (amounts owed to suppliers), accrued liabilities (wages, interest and taxes incurred but unpaid), deferred revenue (cash received for goods or services not yet delivered), and the current portion of long-term debt. Non-current liabilities include long-term debt, lease liabilities, pension obligations, provisions and deferred tax liabilities.
Share capital (common stock plus additional paid-in capital in the US) records what shareholders paid in. Retained earnings is the running total of all profits ever earned minus all dividends ever paid. Accumulated other comprehensive income (AOCI) collects gains and losses that bypass the income statement, such as foreign currency translation. Treasury stock (US) records repurchased shares as a negative; in Canada repurchased shares are usually cancelled and reduce share capital and retained earnings. Non-controlling interest is the part of a subsidiary owned by outsiders.
Maple Outfitters has cash 80, receivables 120, inventory 150 and PP&E 500, for total assets of 850. It owes payables of 90 and debt of 300, so equity is 850 minus 390 = 460. Working capital is 350 minus 90 = 260. Net debt is 300 minus 80 = 220. Book value per share is 460 divided by 100 million shares = $4.60.
US companies list assets from most to least liquid, with current items first. IFRS does not prescribe an order, so some companies present non-current assets first and equity before liabilities. Read the headings rather than assuming a layout. Where a company does not split current and non-current items at all, which is common for banks and insurers, it presents everything in order of liquidity.
Some balances are shown net of an offsetting account. Property, plant and equipment is shown net of accumulated depreciation; receivables net of the allowance for doubtful accounts. The gross figures in the notes tell you how old the assets are and how much of the receivables the company expects never to collect.
Express every line as a percentage of total assets so companies of different sizes can be compared.
| Line | Maple Outfitters | % of total assets |
|---|---|---|
| Cash | 80 | 9.4% |
| Accounts receivable | 120 | 14.1% |
| Inventory | 150 | 17.6% |
| PP&E, net | 500 | 58.8% |
| Total assets | 850 | 100.0% |
| Accounts payable | 90 | 10.6% |
| Debt | 300 | 35.3% |
| Shareholders' equity | 460 | 54.1% |
| Total liabilities and equity | 850 | 100.0% |
Maple is asset-heavy: nearly 59% of its assets are physical. A software company's common-size balance sheet would show little PP&E and a large share of cash, receivables and intangibles.
A company has total assets of 2,000, including goodwill of 300 and other intangibles of 200, and total liabilities of 1,100. It has 50 million shares.
More than half of this company's book value is goodwill and intangibles. If an acquisition goes wrong, an impairment can wipe out much of the book value in one charge. Lenders and bank analysts focus on tangible figures for this reason.
When a parent controls a subsidiary (usually more than 50% of the votes), it consolidates it: 100% of the subsidiary's assets, liabilities, revenue and expenses appear in the parent's statements, and the part owned by outsiders is shown as non-controlling interest. A holding of roughly 20% to 50% that gives significant influence is accounted for by the equity method: one line on the balance sheet for the investment and one line on the income statement for the parent's share of the investee's profit. Smaller holdings are carried as financial assets, usually at fair value.
Some obligations never appear as liabilities: purchase commitments, guarantees of other parties' debt, and interests in entities that are not consolidated. They are disclosed in the notes on commitments and contingencies, which are worth reading in full.
The market value of equity is share price times shares outstanding. The price-to-book ratio compares the two. A ratio well above 1 says investors value assets the balance sheet does not record, such as brands, software, customer relationships and skilled staff. A ratio below 1 can signal a bargain, or assets that are worth less than their carrying amount.
For your two companies from Module 1, compute working capital, net debt, book value per share and tangible book value per share. Note which company carries more goodwill as a share of total assets.
Educational content only; not investment, tax or legal advice. Companies, tickers and figures are illustrative examples, not recommendations. Rules, rates and limits change, so check current details with the regulator, exchange or tax authority before relying on them. Worked examples are not forecasts. Written by Elizabeta Dimoska. RiskStock is not a registered dealer or adviser.