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Financial Statements

Terminology

Bankruptcy

Bankruptcy occurs when a company can no longer pay its debts. The company is usually liquidated which means than all the company's assets are sold and the creditors paid with the proceeds. The creditors normally only receive a portion of the amount they are owned.

Book Value

Book value is a measure that's commonly used in value investing and represents the value of a company's worth per share. The book value is calculated by dividing the net asset value obtained from the company's balance sheet statement by the number of shares outstanding.

Income Statement

A financial statement contained in the annual or quarterly report that is issued by companies and it shows the revenue a company received and expenses incurred during that period. The income statement (which used to be referred to as the profit and loss statement) shows when the revenue and expenses occurred, whereas the cash flow statement shows when the actual payment was received form the revenue and the payments where made for the expenses (which may be in the next period).

Tangible Book Value

Tangible Book Value is a measure that's commonly used in value investing and represents the net value of a company's hard assets. The tangible book value is calculated by subtracting the intangible assets and goodwill from the net asset value obtained from the company's balance sheet statement and dividing this result by the number of shares outstanding. Note: Tangible Book Value excludes the intangible assets whereas Book Value includes the intangible assets.

Reading the Balance Sheet Statement

What the company owns and what it owes

Understanding the Financial Statements - Reading the Balance Sheet Statement;  picture of a road sign post with two signs saying liabilities and assets on a green background in white letters

The balance sheet statement reports the dollar value of the company's assets and liabilities at the end of each accounting period. The most common accounting periods are quarterly for the first three quarters and then one final annual report.

Thus the balance sheet statement provides a snapshot of what the company owns and what it owes, which is effectively reported every three months (four times a year). The financial data taken from the balance sheet statement and from the income statement are used to evaluate a company's financial position and its risk of bankruptcy.

The balance sheet statement is also known as the financial position statement and has three main sections; Assets, Liabilities and Stockholders' Equity.

Assets

Assets are the dollar value of everything the company owns. It includes cash in the bank, office equipment, plant and machinery, stocked products waiting to be sold and any money yet to be received from products sold or services provided.

The assets owned by the company are subdivided based on the asset type. This subdividing is useful for fundamental analysis as many of the ratios use the figures from these subcategories.

Assets are divided into Current assets and Noncurrent assets. Intangible assets are Noncurrent assets that have a special meaning. These are explained as follows.

  • Current assets: These are tangible assets that a company can readily use or convert to cash fairly quickly (generally within one year). They typically include the dollar balances of all bank accounts, accounts receivable and any inventory (unsold goods on hand). Current assets can include prepaid expenses or anything else that can be converted into cash within one year.
  • Noncurrent assets: These tangible assets are also referred to as fixed assets and can not be quickly converted to cash. These assets are long-term assets and include all property, plant and equipment, office furniture, motor vehicles. These assets can not be treated as an expense in the year they are acquired and must be depreciated over their lifespan. Depreciation is an accounting process where the original cost of the asset is divided by the expected usable life of the asset, and this value is then a deductible expense. Depreciation may also be listed as amortization. An exception to the depreciation rule is the Land value in real estate property, because land does not depreciate as it cannot be worn out. Only the value of the buildings can be depreciated.
  • Intangible assets: These are assets that have no physical value. That is, they can not be physically touched or picked up. Brand names are good examples of intangible assets, the product itself is physical but the brand name of the product is not physical, its just a name but it can have significant value (Coco Cola for example). Another example of an intangible asset is the "covenant not to compete". This occurs when a business is sold and the seller contractually agrees not to set up a new competing business for a certain number of years. While not a physical asset, the value to the business buyer is in the lowered competition and customer loyalty received from the previous owner. Goodwill is a distinct type of intangible asset which represents the amount of money a company is worth above its assets value.

Intangible assets are considered long-term and are included with the Noncurrent assets section on the balance sheet statement.

Liabilities

This is the dollar value of all the borrowed money that the company owes. It includes loans from banks, money obtained from issuing corporate bonds and any unpaid bills.

  • Current liabilities: These are short-term liabilities that will be paid within the next 12 months. Current liabilities include any accounts payable (such as utility bills), any taxes to be paid to local, state and federal agencies for payroll or other taxes, and includes 12 months worth of any loan repayments. Current liabilities are short-term and can be directly compared to current assets, and the net difference between current assets and current liabilities is known as working capital.
  • Noncurrent liabilities: These are long-term liabilities which will not be repaid within the next year. Noncurrent liabilities include all long-term loans made to the company, typically money that was used to acquire its long term noncurrent assets.

Stockholders' Equity

This is the net value of the company and it is what the Stockholder's own. The Stockholders' Equity is simply the difference between what is owned and what is owed, which is the company's net assets.

Stockholders' Equity also includes any net earnings that the company did not pay out to their stockholder's via a dividend and thus reinvested back into the company as retained earnings.

The Stockholders' Equity is not necessarily the business value of the company as any goodwill and intangible assets which are internally generated are not included. Only the goodwill and intangible assets from businesses acquired are included. The Stockholders' Equity will only equal the company's business value if all of its assets were acquired from other businesses.

The Stockholders' Equity is usually reported in a summary format on the balance sheet statement and typically includes the value of common stock, treasury stock and any retained earnings along with the total value.

Normally the Stockholder' Equity is also reported in a separate statement which contains a more detailed breakdown of its items, with only a summary included in the Stockholders' Equity section of the balance sheet statement.

The main reasoning for this is that most institutional investors require detailed information on Stockholders' Equity and if the accountants were to include this, the balance sheet statement would become too large and skewed with stockholders' information. Therefore it is common practice for accountants to only include a summary in the balance sheet statement and to provide a separate fourth statement detailing Stockholders' Equity.

Book Value

The book value of a public company used to refer to its net tangible assets which excluded goodwill and intangible assets. This is generally the same with private businesses.

Nowadays the book value of public companies usually includes the goodwill and intangible assets which make it the same as the Stockholders' Equity.

To avoid confusion, the term "tangible book value" is used when the intangibles and goodwill are excluded from the book value.

Balance Sheet

For the balance sheet to balance, the total assets less total liabilities must equal the Stockholders' equity.

For an annual statement, the balance sheet statement shows the current fiscal year along side the previous fiscal year for comparative purposes. For a quarterly statement, the balance sheet statement shows the current period along side the previous corresponding period (which is the same quarter a year ago).

An example of a simplified balance sheet statement is shown below in Table 1.



Table 1. Example of a simplified balance

sheet statement

2017 2016
Current Assets
Cash 7,000 6,000
Accounts receivable 15,000 16,000
Inventory 2,000 1,000
Total Current Assets 24,000 23,000
Noncurrent Assets
Property and equipment 10,000 11,000
Intangible assets 2,000 1,000
Goodwill 3,000 3,000
Total Noncurrent Assets 15,000 15,000
Total Assets 39,000 38,000
Current Liabilities
Accounts payable 4,000 3,000
Taxes payable 1,000 1,000
Total Current Liabilities 5,000 4,000
Noncurrent Liabilities
Long term debt 11,000 12,000
Other liabilities 2,000 2,000
Total Noncurrent Liabilities 13,000 14,000
Total Liabilities 18,000 18,000
Stockholders' Equity
Common stock 20,000 18,000
Retained earnings 1,000 2,000
Total Stockholders' Equity 21,000 20,000
Total Liabilities and Stockholder's Equity 39,000 38,000

A company's actual balance sheet statement will have significantly more items listed for each category than the simplified example above. The amount and the type of items listed in each category vary from company to company and between industries. However, the basic format of listing the categories remains consistent. The Current assets are listed first, then the Noncurrent assets, then Current Liabilities, then Noncurrent Liabilities and finally the Stockholders' Equity.

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