Balance sheet 201

1. Balance Sheet
Here we discuss how to build and interpret the balance sheet
1. The balance sheet is a snapshot of one day; it does not measure a period
of time. It tells you the state of your assets today.
a. The balance sheet almost always accompanies an income
statement
i. The balance sheet is prepared on the last day of the
income statement period
2. Balance Sheets are constructed according to US GAAP
a. GAAP = Generally Accepted Accounting Principles
i. GAAP is a standard required to make all balance sheet
statements comparable.
1. Other standards exist around the world, most
notably IFRS in Europe
3. One major rule about Balance Sheets
a. They are based on historical cost
i. Whatever an asset cost to purchase, that cost is on the
balance sheet (with very few exceptions)
4. Companies pay for assets in two ways
a. With Debt (liabilities) or Equity
i. For this reason there is a very famous equation
1. Assets = Liabilities + Equity
a. You could also rearrange this an see that
i. Equity = Assets – Liabilities
5. The balance sheet is constructed in this order, from top to bottom
a. Assets
b. Liabilities
c. Equity
i. And, as stated above, Assets – Liabilities = Equity
6. The Asset Section is divided in two
a. Current Assets
i. Current assets are either
1. Cash and Cash Equivalents
2. Assets that will turn into cash withinone year
a. Inventory, Accounts Receivable, prepaid
expenses, other
b. Non-Current Asset
i. Are assets that will be turned into cash in more than one
year
1. It takes a long time to monetize Plants Property &
and Equipment
a. Or receivables that will pay of in one year
b. Or Intangibles that get monetized over
decades

2. ii. Intangibles are assets that are very hard to measure but are
often very important
1. For coca cola, the brand has enormous value, much
more than any physical asset, and probably more
than all physical assets. How do you measure this
a. These are called intangible assets
i. The balance sheet attempts to measure
them, but they are subject to great
amounts of subjectivity
7. The Liabilities Section is divided in two
a. Current Liabilities
i. Are all liabilities that must be paid for within one year
1. The most notable are
a. Accounts Payable
b. Debt due within one year
b. Non-current Liabilities
i. Assets that will be paid off in more than one year
1. The most notable is (usually) debt
c. There are also non-debt line items in both Current and Non-
current liabilities that function like debt
i. Pension expense
ii. Asset Retirement Obligations, etc
8. Equity is a residual value
a. It is what is left over when you subtract all liabilities from total
debt
i. This is what theoretically belongs to the shareholders
9. Equity is sometimes referred to as book value or net worth. All of these
terms are interchangeable.
a. Some investor like to buy stocks that trade a market value that is
below book value.
i. Why is this the case
ii. Well, the market value is simply the markets opinion
(forward looking) as to the value of the company’s equity.
The book value is the financial statement opinion (as based
on historical cost) of the companies equity. In essence by
buying it on the market for less than book value, you are
paying for the equity less than what it originally took to
create these set of assets.
10.The movements in the balance sheet are important to understand. A
few examples are in order
a. Say that we book a sale and we get from that sale 300 dollars in
earnings and 900 in receivables
i. Cash and Cash Equivalents goes up by 300
ii. Receivables goes up by 900
1. Total assets goes up by 1200
2. Equity goes up by 1200

3. a. Why does Equity go up.
i. Remember the balance sheet equation?
Equity = Assets – liabilities
ii. This equation must always be trouble
iii. If assets go up by 1200 and liabilities
stay the same Equity must go up. It
goes up through retained earnings
b. Say that the customer then pays us the 900 in receivables
i. Cash goes up by 900 but receivables goes down by 900
ii. The assets are left unchanged by the netting of these two
figures.
1. The assets increased at the moment of the sale, not
when the cash was collected.
c. Say that a supplier sends us 500 in inventory before we pay them
i. Accounts payable goes up by 500
1. Remember, this is a liability
ii. Inventory goes up by 500
1. Remember, this is an asset
iii. This means that there is no increase in equity. The two
figures net each other out
d. say that we then pay the supplier the 500 we owe them
i. Cash goes down by 500 and Accounts payable goes down by
500
1. Again, equity is entirely unaffected.
2. So we momentarily increased assets by issuing a
liability, but when the liability was paid off we
brought our assets back to their original level
3. In this way, payables act like short-term loans with
no interest expense.