What Do I See?

What Do I See?

Learning Objectives

  1. Identify things to look for on all financial statements.

  2. Apply a hierarchical approach to analyzing numbers reported on balance sheets.

  • Click the Express Route video below for an overview.
  • Click one of the topics in the Scenic Route video for more explanations and examples of real companies’ balance sheets.
  • If you’re ready to start the exercises, click the exercise link below. Go back to the Scenic Route topics if you need more help.

Express Video:

 Click here for the Express Route video [16 minutes]

Scenic Videos:

Click one of the topics below for a Scenic Route video

 

1. Reporting Dates and Periods [9 minutes]

2. Reporting Entity [12 minutes]

3. Basis of Presentation [11 minutes]

4. Primary Elements [14 minutes]

5. Major Categories [15 minutes]

6. Line Items [31 minutes]

Exercises

 Ready to do exercises?   Click for exercises for this module

  

Take-aways:
  • Balance sheets are vertical expressions of the balance-sheet equation and illustrate that the financial measures of a company’s assets and claims must always be equal: Assets (A) = Liabilities (L) + Owners’ Equity (OE)

  • There are several things to look for on all financial statements, including balance sheets: the reporting dates and periods, fiscal year ends, reporting entity, currency, and rounding (e.g., millions or thousands). In the accompanying notes in annual reports, companies disclose the generally accepted accounting principles (GAAP) to which the reports comply. These notes are especially important to consider when comparing two or more companies.

  • Balance sheets help insiders and outsiders assess a company’s financial condition: ability to execute its strategies, meet its financial obligations, and respond quickly to unforeseen opportunities and challenges. You should start your assessment with the primary balance-sheet classes, examine the current and non-current assets and liabilities, and then the individual balance-sheet line items.

  • Balance sheets are often described as financial pictures of a company at a point in time. However, they are fuzzy pictures. Companies have many resources and obligations that are not on their balance sheets. This means it is particularly important to interpret the numbers in a broader context. In the next module, we start by considering what’s behind the numbers and relating this to the business and the environment in which the company competes. This will help you better interpret a company’s balance sheet and other financial information.

Key terms:

  • Asset- Resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.1

  • Liability- Present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.Liabilities are creditors’ claim on entity’s assets. Companies incur liabilities when they do something today, or discover they did something in the past that indicates they are obligated to sacrifice economic benefits in the future to other entities (creditors) to meet an obligation.

  • Equity- Residual interest in the assets of the entity after deducting all its liabilities.3 Total owners’ equity is the accounting or book value of the owners’ claims, which generally differs from fair values. Owners have residual claims on a company’s assets, meaning creditors are paid first in the event the company goes out of business or files for bankruptcy. Also called stockholders’ equity or shareholders’ equity.

  • Financial leverage-  Measures the degree to which a company’s assets are funded through owners’ equity versus liabilities. Also, extent to which owners can amplify their expected returns by issuing debt rather than issuing stock.

Key formulas:

  • Financial leverage4 = total liabilities / total assets
  • Working capital = current assets – current liabilities
  • Current ratio = current assets / current liabilities

1 International Accounting Standards Board Framework, ¶ 49(a)

2 IASB Framework, ¶ 49(b)

3 IASB Framework, ¶ 49(c)

4 There is no universally accepted measure for financial leverage. Typically, it’s measured using one of the following: L/A, A/OE, or L/OE, also called debt-to-equity ratio. The financial leverage numbers differ for the formulas, but the conclusions you draw when comparing financial leverage across companies (or over time for the same company) will be the same, providing you use the same formula for all computations.

 

 

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