Reading a Balance Sheet

Reading furnishes the mind only with materials of

knowledge. It is thinking that makes what we read ours
John Locke

1. Read the following text and answer the questions:

Who and what is the balance sheet relevant for?

What would be the main difference between accounts payable and accounts
receivable?

What financial ratios can be calculated by reading a balance sheet?

2. Match the following terms with their correspondent explanations: inventory, fixed
assets, current liabilities, retained earnings, current assets, accounts receivable,
owners equity, intangible assets, accounts payable

They have a life span of one year or less, meaning they can easily be converted into
cash.

They are typically paid within one year or less and are therefore paid with current
assets. Because current assets pay for them, the ratio between the two is important: a
company should have enough of the former to cover the latter.

They have a life span of over one year. Depreciation is calculated and deducted from
these types of assets.

The initial amount of money invested into a business.

They are the short-term obligations owed to the company from clients. It represents
the amount of materials currently available for production.

What the company owes to suppliers for buying raw materials or retail products on
credit.

While these assets are not physical in nature, they are often the resources that can
make or break a company.

The percentage of net earnings not paid out as dividends, but kept by the company to
be reinvested in its core business or to pay debt. It is recorded under shareholders
equity on the balance sheet.

A balance sheet reveals a companys assets, liabilities and owners equity, also called
net worth. The balance sheet provides all the necessary information to shareholders, those
people who contribute with their money to the internal financing of a company, in exchange
for dividends.
The balance sheet is divided into two parts:
assets = liabilities + owners equity
Assets are what a company uses for its production process, while liabilities are
obligations to be paid to outside parties. Owners equity, referred to as shareholders equity in
a PLC, is the amount of money initially invested into the company plus any retained earnings.
Retained earnings are calculated as following:
Retained earnings (RE) = Beginning retained earnings + Net income
- Dividends
In most cases, companies retain earnings in order to invest them in, for example,
buying new machinery or spend the money on research and development.
If beginning RE + Net income Dividends > RE, then the company is registering a
deficit.

A balance sheet represents a specific period (usually one day) and is most usually
calculated on the last day of a companys fiscal year, Dec 31.

ASSETS
Current assets
cash and cash equivalent
accounts receivable

LIABILITIES
Current liabilities
Dividends payable
Accounts payable

ASSETS
inventory
Raw materials
Work-in-progress (WIP)
Finished goods
Bank accounts
Checks
Stocks
T-bills
Fixed assets or tangible assets
Machinery
Computers
Building
Land
Intangible assets
Patent
Copyright
Goodwill
Franchises and licenses
Leasing

LIABILITIES
Interest payment on long-term debt
Taxes payable
Owners equity

If, at the end of the fiscal year, a company decides to reinvest its net earnings into the
company, the retained earnings will be restated from the income statement into the balance
sheet.
net earnings + retained earnings = total net worth
For a balance sheet to be functional, total assets on the left side have, at least, to equal
total liabilities plus owners equity on the right side.

A balance sheet:

It is also a support for the financial ratios to be calculated

It helps an investor to realize how liquid a company is and to analyze its growth
potential

It shows how profits are used to finance the companys operations and whether the
company has enough cash for growth

It points to the inventory levels, whether they are stagnant or in progress, if debt is
paid or to be paid

It shows what cash value would shareholders receive in case of bankruptcy

It shows what is the value of current assets, those assets which can be easily converted
into cash.

3. Look at this example of a balance sheet. Fill in the missing words. Choose from the
following: patents, owners equity, accounts receivable, land, capital, accounts
payable, WIP, current assets

BALANCE SHEET
(All figures in RON)
Assets
Cash
T-bills

Total Current Assets

Inventory
Raw materials

2005
5.000
500
1.000
7.000
13.50
0
825

Finished Goods

750
1.200

Total Inventory

2.775

Long-term assets

Machinery
Depreciation (machinery)
Intangible assets

Total Long-term assets

Total Assets

Liabilities and owners equity

Current Liabilities
Dividend payable
Taxes payable
Total Current Liabilities
Long-term Liabilities
Long-term Bank Loan
Total Liabilities

1.000
46.00
0
62.27
5

4.000
2.000
3.000
9.000
5.000
14.00
0

Total Net Worth

20.00
0
28.27
5
48.27
5

Total Liabilities + Net Worth

62.27
5

Retained Earnings
30.00
0
20.00
0
5.000

2005

4. Read now the complete balance sheet above and provide answers to the requirements
below:

Is the company liquid enough to pay off its debts, or it needs to take a loan?

Is the company financing itself through reinvested earnings or debt?

What does a low cash ratio indicate?

Calculate the debt ratio by using the balance sheet above.

Calculate the current ratio by using the balance sheet above

What would a high amount of leverage indicate?