Chapter 1
The Balance Sheet
THE BALANCE SHEET IS A representation of the company’s financial health. It is produced as of a specific point in time, usually the end of the fiscal (accounting) year or month. It lists the assets that the company owns and the liabilities that the company owes to others; the difference between the two represents
The ownership position (stockholders’ equity).
More specifically, the balance sheet tells us about the company’s:
Liquidity: The company’s ability to meet its current obligations.
Financial health: The company’s ability to meet its obligations over the long term; this concept is similar to liquidity except that it takes a long-term perspective. It also incorporates strategic issues.
Financial strength refers to the company’s ability to:
– Secure adequate resources to finance its future
– Maintain and expand efficient operations
– Properly support its marketing efforts
– Use technology to profitable advantage
– Successfully compete
The balance sheet also helps us to measure the company’s operating performance. This includes the amount of profits and cash flow generated relative to:
– Owners’ investment (stockholders’ equity)
– Total resources available (assets)
– Amount of business generated (revenue)
By analyzing the data in the balance sheet, we can evaluate the company’s asset management performance. This includes the management of:
– Inventory, measured with an inventory turnover ratio
– Customer credit, reflected by an accounts receivable measure known as days sales outstanding or collection period
– Total asset turnover, which reflects capital intensity, degree of vertical integration, and management efficiency
Mathematical formulas called ratios are very valuable in the
analytical process. They should be used to compare the company’s current performance against:
– Its standards of performance (budget)
– Its past history (trends)
– The performance of other companies in a similar business (benchmarking)
Look at the balance sheet of the Metropolitan Manufacturing Company, shown in Exhibit 1-1, dated as of December 31, 2002.
Notice that it also gives comparable figures for December 31, 2001. Providing the information for the prior year is called a reference point. This is essential for understanding and analyzing the information and should always be included. The third column gives the differences in the dollar amounts between the two years. This information summarizes cash flow changes that have occurred between December 31, 2001, and December 31, 2002.
This very critical information is presented more explicitly in the report called the sources and uses of funds statement or the statement of cash flows. This is described more fully in Chapter 3. (The numbers in parentheses in the fourth column refer to the lines in Exhibit 3-1, the Sources and Uses of Funds Statement.)
The Balance Sheet
Exhibit 1-1. Metropolitan Manufacturing Company, Inc.
Comparative Balance Sheets
December 31, 2002 and December 31, 2001 ($000)
2002 2001 Changes
1. Cash $ 133 $ 107 + 26 (47)
2. Marketable Securiti 10 10
3. Accounts Receivable 637 597 + 40 (43)
4. Inventory 1,229 931 + 298 (42
5. Current Assets $2,009 $1,645
6. Investments 59 62 – 3 (39)
7. Fixed Assets:
8. Gross Book Value $1,683 $1,649 + 34 (41)
9.
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