By elmads

In investing, the balance sheet reflects the general health and safeness of a company. Their ability to survive crises that may happen in the future through having great buffers like cash liquidity.

Balance sheet is a snapshot of a company’s asset, liability and equity in a specific point in time. It is presented in a yearly basis

It is called a balance sheet because Assets must equal the Liabilities plus the Equity the company has. This is more of an accounting point of view. As investors we generally do not focus about this matter.

• Assets are what the companies own – In an individual level it is all the things that we own

• Liabilities are what the company owes – In an individual level it is our debt responsibilities and other things we owe

• Equity – It is the total ownership of a company when Liabilities are subtracted to its Assets. It is called net worth in an individual level. Equities is also considered a liability because some of the company’s assets are actually the ownership of the shareholders. That is why Assets = Liabilities + Shareholder’s Equity. The better explanation for this is, some of the assets of the company are owed to people who lent some of their money to the company (they’re called the creditors), then the remaining assets are all for the owners of the company (the shareholders/investors of the company).

In this blog I will be using Apple Inc’s 2020 balance sheet data as an example. We will be focusing in the year 2020, numbers. Just like in the income statement, we need to be aware of two things. First the date of the report and second the minimum amount of money and the currency that the report shows. In this case it is in millions of USD, and both in the year of 2019 and 2020.

ASSETS AND LIABILITIES

Both of them have what we call current and non-current categories. Current Assets are assets that can be easily converted to cash, if not cash itself, within a year. Whereas, current liabilities are liabilities that need to be paid within a year.

In conjunction, non-current assets are assets that will take more than a year to be converted whereas, Non-current liabilities are liabilities that will be due more than a year. Current Assets/Liabilities are for Short-term (less than 12 months) and Non-current Assets/Liabilities are for Long-term (more than 12 months).

CURRENT ASSETS

• Cash and Cash Equivalents – It is what it literally states, the cash that the company has and any assets that can be quickly converted into cash instantly, such as online wallets and money market funds.

• Marketable Securities/Short-term Investments – these are investments that can be liquidated within a year namely certificate of deposits, treasury notes and bills. In an individual level, these can also be the savings we have in our savings accounts.

• Net Accounts Receivables – this is the total amount of money that the customer owes to the company, minus the chance of the consumers not able to pay back their debts to the company. For instance, if we bought an iPhone product worth £999.00 using our credit card, this will then translate as an income TO BE received by Apple, this is because we did not give them money immediately instead we used the credit card to pay for it, so we still owe Apple a debt of £999.00 worth of our money. Furthermore, Apple will take into consideration the chance that we will not be able to pay for our debt. That is why this is called NET ACCOUNTS RECEIVABLES.

• Inventory – These are the expected finished products to be sold within 12 months. Included here are the finished products that are ready to be shipped and sold to their customers, work-in-progress goods and raw materials that are needed to produce the company’s goods. In Apple’s case, see sample below;

  -Finished products – iPhone, iPad, Mac book and other hardware they sell.

  -Work-in-progress – unfinished products

  -Raw materials – aluminium, lithium, cobalt and others more.

• Non-trade Receivables – are receivables that are not directly related to the business operation of the company. Examples are, employee loans, salary advances and insurance claims. Just always remember that when you see or hear the word RECEIVABLES in a company statement, this means that someone or another company OWE THEM MONEY and they are expecting to receive it in the near future.

• Other Current Assets – mostly what is included here is the prepaid expenses, which is basically the advance payment for an activity, commonly with rent and advertising. This is common with the administrative part of the company’s operations.

NON-CURRENT ASSETS

• Marketable Securities/Long-term Investments – These are investments that the company will hold for more than a year. These investments can be stocks, bonds, real estate, commodities and others more. Moreover, these are investments that are not related to the company.

• Property, Plant and Equipment/PP&E – These are tangible assets (physical assets that can be seen and touched.) that are essential for the business operations and cannot be converted to cash easily. Examples are lands, buildings, vehicles, furniture, and machineries.

• Intangible assets – this is not included in Apple’s balance sheet above but this is important. This is a non-physical asset of a company where the amount of money is based on their copyright, trademark and patent. Brand recognition is under intangible assets.

• Other Non-Current Assets – Assets that are not included in the previous category. To further know about this row in a balance sheet, we need to look into the foot notes of the company’s annual report statement, which shows the specific breakdown of this section. The contents of this portion can different per company and per industry.

CURRENT LIABILITIES

• Accounts Payable – This the counter part of the accounts receivable of the current assets portion. In here, the company has an invoice, debt and bills to be paid to their creditors and suppliers for the products and services that they delivered to the company already, in this case Apple. Just always remember that when you see or hear the word PAYABLES in a company statement, this means that the company we are looking into, are EXPECTED TO PAY their invoices and bills to their suppliers, because they purchased the supplies via credit.

• Short-term debts – This is an important part because it shows the portion of a company’s long-term debt that they need to pay within the year hence, Shor-term debt.

• Other Current Liabilities – See the foot notes section of the company’s annual statement report, in order to see the breakdown of this portion. Remember that every company and industry have different “Other” portion for either assets or liabilities.

• Commercial Paper and Repurchase Agreement – Not all companies have this segment in their balance sheet. Basically this is a short-term debt instrument that the company issues in order to finance short-term responsibilities in their company, like employee salary. This a debt for the company that they need to pay back to their investors in the money market. I have discussed this in my blog titled “The Financial Markets”.

• Deferred Revenue – Remember the top line in the income statement, called the “Revenue”? this is it but with significant difference. In here, the company has not yet delivered or shipped the products or services to the consumer that is why the expected amount of money for that product is considered unearned revenue/deferred revenue. In particular, you ordered an iPhone worth £999, the company receive already that £999 but they still consider it as an unearned income, because the customer has not received yet the product. It is a liability because, the company still owes the product to the customer, if the product is not received or the customer cancels the order then the company will need to return the money back to them. That’s why in a sense, it is still an unearned revenue. Nevertheless, once the product has been received by the consumer, then that will be automatically reflected into the company’s revenue in their income statement.

NON-CURRENT LIABILITIES

• Long-term Debt – This is the debt the company acquires, which they do not need to pay within a year. Company obtains debt commonly through bond issuance. Remember the bond asset class? in which companies issue a bond for investors to buy with the promise and expectation for the company to pay a specified interest payment back to their bond holders. I discussed this further in my blog titled “The Bonds Asset Class”.

• Other Non-Current Liabilities – See the foot notes section of the company’s annual statement report, in order to see the breakdown of this portion. Remember that every company and industry have different “Other” portion for either assets or liabilities.

SHAREHOLDER’S EQUITY

• Common Stock – This is the number of shares the company issued at par value. It is the number of shares that the company issues (decided by directors of the company) times the par value (the amount, usually the current stock price of the company). I have discussed this further in my blog titled “Stocks and Shares” and “Initial Public Offering and The Capital Markets”.

• Retained Earnings – This is the Net income of a company that has been retained into the company after a certain period. The term also refers to the historical profits earned by a company, minus any dividends it paid in the past. To make it more understandable, I’ll show you the simple formula for retained Earnings

Retained Earnings from the previous year + Net Income this Year – Cash Dividends paid to their stockholders – Stock Dividends paid to their stockholders.

as Warren Buffett has said;

Many stock options in the corporate world have worked in exactly that fashion: they have gained in value simply because management retained earnings, not because it did well with the capital in its hands.

Warren Buffett

• Accumulated other comprehensive income/(loss) – This is the unrealized gains/losses of the company investments, pension plans and other transactions. It is like our personal investing portfolios, in which the overall total portfolio price fluctuates either in the positive or negative side. If we have not sold it yet, then it will be called unrealized gains or losses. On the other hand, if we sell our investments either at a gain or a loss, we now call that as realized actual gains/losses.

Just an additional information. The Total Assets should always be equal to the Total Liabilities plus the Total Equities. This is why it is called The Balance Sheet.

To sum it up

Understanding the balance sheet is understanding if the company is healthy enough to weather the storms such as financial crisis, pandemics, and other unforeseeable problems both in the micro and macroeconomic space. Knowing the both the income statement and balance sheet is a pre-requisite into understanding one of the most important principles in investing, and that is the margin of safety principle, coined by Benjamin Graham. Margin of safety, as per Warren Buffet , is like driving a truck onto a bridge;

“You leave yourself an enormous margin of safety. You build a bridge that 30,000-pound trucks can go across and then you drive 10,000-pound trucks across it. That is the way I like to go across bridges.”

-Warren Buffett

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.