Understanding the balance sheet - Deepstash

Understanding the balance sheet

A balance sheet shows what a business owns at a particular time. A balance sheet always balances. Assets = liabilities + owners’ equity.

  • Assets: What the company owns. It is more estimates and assumptions. Assets include cash; accounts receivable; inventory; property, plant, and equipment (PPE) minus accumulated depreciation; goodwill; intellectual property, patens; accruals.
  • Liabilities: What the company owes.
  • Equity: The assets - liabilities.

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MORE IDEAS FROM Financial Intelligence

The art of accounting is taking a limited set of data to get an accurate description of how well a company is doing.

Definitions to understand.

  • Revenue is when a service/product is delivered.
  • The income statement shows sales/revenues, costs/expenses, and profit. You can often tell what’s important to a company by looking at the biggest numbers relative to sales.
  • Operating Expenses: Day-to-day costs needed to keep the business going, e.g., salaries.
  • Capital Expenditure: The cost of purchasing an item is considered a long-term investment, such as computer systems or equipment.

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Financially intelligent managers understand the four distinct skill sets:

  1. The Foundation. They can read an income statement, a balance sheet and a cash flow statement. Can differentiate between profit and cash.
  2. The art of finance. They can identify the artful aspects of finance and know how applying them differently can lead to different conclusions.
  3. Analysis. They use ratios, return on investment (ROI) analysis, etc. to make better decisions.
  4. The big picture. Numbers can’t (and don’t) tell the whole story. Financial results should be understood within the framework of the big picture.

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Profit is not cash. A healthy business needs both profit and cash.

Inflows: Cash moving into a business

Outflows: Cash moving out of a business

Types of cash flow:

  • Cash from operating activities
  • Cash from investing activities
  • Cash from financing activities

Financing a company: Getting a company the cash it needs to start up or expand.

Cash flow can be calculated by looking at the income statement and two balance sheets. When you know a company’s cash situation, you can understand what’s going on now, where the business is headed, and the priorities of senior management.

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Understanding how the numbers are used and what are assumptions puts you in control of the decisions.

  • Goodwill: The difference between the net assets acquired and the amount of money the acquiring company pays form them.
  • Balance sheet: The balance sheets show the assets, liabilities, and owners’ equity.
  • Cash shown on a balance sheet is money in the bank and things like stocks and bonds that can be turned into cash.

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It consists of three main categories:

  • Sales or revenue during a given time period. It includes sales (revenue) and Earnings-per-share (EPS)
  • Costs and expenses: “Above the line” are the cost of goods sold (COGS), cost of services (COS). “Below the line” are operating expenses, interest, taxes, depreciation and amortization.
  • Profit: Profit is an estimate. You can’t spend estimates. 

Different kinds of profit:

  • Profit = Revenue - expenses
  • Gross profit = Sales - COGS
  • Operating profit (EBIT) = Gross Profit - Operating expenses
  • Net Profit = Operating Profit - (interest + taxes + other costs)

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Accountants use accruals and allocations to attempt an accurate picture of the business for a month.

  • Accruals: An accrual is the part of a revenue or expense item that is recorded for a specific period, e.g., product development costs. The purpose is to match costs to revenues in a given timeframe.
  • Allocations: Theses are apportionments of costs to different departments or activities in a company.
  • Depreciation: Allocated cost of equipment and other assets to the total cost of product and services shown on the income statement.

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A good manager is aware of how both cash and profits affect a balance sheet. A balance sheet shows if a company is financially healthy.

The balance sheet answers the following questions:

  • Do the assets outweigh the liabilities?
  • Can the company pay its bills?
  • Is the owner’s equity growing?

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