The Balance Sheet Breakdown is a four part series on understanding each section of the balance sheet that is provided by public companies.  By understanding the balance sheet, you will have a gauge of the financial health of the company and whether or not it is a sound investment for you.  Start out with Part 1.

The Assets portion of the balance sheet is broken down into several subsections. It represents all that the company owns and all that is owed to the company.  It is considered to be the left side of the equation with liabilities and shareholders equity added together to equal assets in the balance sheet equation. The high level asset classes are Current Assets, Capital Assets, Deferred Charges, Intangible Assets, Goodwill, Miscellaneous Assets.

Current Assets

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Current assets are anything that can be turned into cash in a short period of time.  This is considered the most important asset because it determines whether or not companies have the ability to pay their bills.  Without having the ability to turn their assets into cash, they will become insolvent.  Not a good thing.  There are several items which are categorized under the Current Asset class:

  • Cash - Pretty self-explanatory category
  • Temporary Investments – Investments in stocks or bonds that can be easily cashed
  • Accounts Receivable – Money that is owed to the company from customers.  In this section there is usually a line item included for doubtful accounts where payment is not necessarily expected.  This allowance is subtracted from the overall accounts receivable total.
  • Prepaid Expenses – These are costs that will be incurred in the future but have already been paid for.  Because the are considered bills that would need to be paid from cash anyway, it is considered to be as good as cash in the balance sheet calculations.
  • Inventories – Provide for an interesting accounting challenge when accounting for them on a balance since they can be recorded in different methods.  They are recorded at the lower of original cost or current market value.  If the original cost is used, there are three ways of determining the cost of those inventories; First-In-First-Out (FIFO), Last-In-First-Out (LIFO) and Average Cost.
  • FIFO – Items acquired first are sold first and taken out of inventory first
  • LIFO – Items newest to inventory are sold first and taken out of inventory first
  • Average Cost – Takes the average price of inventory costs and spreads them out.

Capital Assets

The bulk of capital assets relates to property, plant and equipment ownership.  However it can go down as detailed as office furnishing, and trucks, along with anything else used to help day-to-day operations.  There is no intention of selling these assets to turn them into cash like current assets.  The value in capital assets is how they help in producing products and sales.

When recorded on a balance sheet, capital assets are entered at their original cost plus any expenses incurred in the installation, or delivery.  Capital assets (except land) are amortized for each year of useful life (depreciation) and the accumulated amount is subtracted from the original cost of the equipment.  Once this calculation is complete the resulting value is called the net carrying amount.   Often times on balance sheets you will see an entry for non-operating income and this is as a result of the selling of a capital asset. This amount is the sale price subtracted by the net carrying amount.

Deferred Charges

Deferred charges will often appear on balance sheets and are similar to prepaid expenses which are considered current assets.  The difference is that deferred charges are payments that the company made for services/goods further into the future than can be accounted for in current operations (usually more than one year out).  These charges will be gradually written off year after year as the benefits are realized.  This process is similar to that of amortization of capital assets.

Intangible Assets

These assets are ones that cannot be physically touched or effectively measured in a quantitative way.  They can’t be used to pay off debts are usually not worth much in value once a company goes out of business.  They are primarily legal rights that are used to protect the interests of the company (eg: trademarks, patents, copyrights, etc.).

Goodwill Assets

This section involves the probability that a loyal customer will continue to do business with the company.  Because of a good name or reputation, people will continue to return to do business and investors will likely be willing to pay a premium to invest in the company.  This premium for goodwill appears on the balance sheet as the excess amount paid for shares above the net asset value.

Miscellaneous Assets

These assets are ones that are difficult to classify as either short term or fixed long term.  Some of the more common miscellaneous assets include long-term investments, investments in subsidiary companies, and cash value of life insurance.

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