Balance Sheet Analysis

• It is the starting place to analyze a company's financial strength.
• It lists all of a company’s assets, liabilities and equity at a certain point in time.
• A snapshot of a firm at end of fiscal quarter - represents the toal impact of all transaactions at a certain date. 
• Asset = Liabilities + Equity
• Asset - items that the company owns and use to conduct business
• Liabialities - what the company owes to others
• Equity - what is left over (net worth)
• Different companies will report different line items on their balance sheet.
• Banks are noticeably different due to their distinctive business nature.
• Notes to financial statements provide further details on the construction of various blanace sheets accounts & the assumptions behind the reported figures.
• Assets
• What a firm owns?
• Current Assets
• Highly Liquid and intended to be used during current business cycle \ course of the next year
• Listed in order of liquidity- begining with cash & cash equivalents (most liquid asset)
• Cash Equivalents - include money invested in higly liquid assets for use within 90 day. (e.g. money market funds and short term treasury bills)
• Cash Balance - vary depending on industry. e.g. manufacturing need more cash than technology. Need to evaluate cash against competitors and industry norm.
• Current Ratio (Current Assets/Current Liabilities) and Quick Ratio([Current Assets - Inventory]/ Current Liabilities) - provide insight in cash levels.
• Too little cash - does it able to maintain daily operations and pay obligations?
• Too much cash - may reduce the earnings potential of a firm.  It may also spur management to make poor decisions instead of making prudent investments or returning value to shareholders.
• High growth company need cash on hand to fund expansion.
• Slowing business - cash level rise as expenditures are curtailed at a pace faster than the decline in revenue.
• Accounts Receivable -the amount owed to the firm from credit extended to customers' purchases
• Low AR - [1] company is efficient in collecting its payments, [2] credit standard strict (might depress sales), [3] operate in a payment on demand mode (e.g. restaurants)
• High AR - [1] having difficulty collecting payments [2] credit standards too loose.
• Analysis the AR figure over several years to understang a firm AR figure.
• Red Flag - AR increasing at faster rate than revnue. [1] Signaling the firm may be relaxing credit standards to boost sales.[2] Customer are having problems paying their bills
• Allowance for doubtful accounts - contra-asset account, managment estimations on the dollar amount that will be defaults.
• AR turnover - Net Credit Sales / Average AR - a significant change should be investigated. It is varies by industry - F&B have higher cash transaction than automotive and it leading higher AR turnover.
• Inventory - include parts, raw materials, products and other unsold goods.
• Certain inventory level is needed for firs to met demant and not lose sales opportunities.
• High inventory - risk for not able to convert inventory to sales. important in industries with constant product innovation (it can be obsolete)
• Low inventory - lose customers who are buying products and expect them within days.
• Prepaid Expenses - include account for goods and services that have been paid for but not yet consumed. E.g. unexpired portion for insurance premium
• Long-Tern Assets
• Non intended to be used during current business cycle \ within 12 months
• Plant, property and equipment -fixed asset that a company acquires to maintain operations
• Depreciation - cost of fixed assets that bieng written off as non cash expenses each year. And, some assets depreciate faster than other.
• Capital intensive industries will have more invested in fixed assets (machine & factories)
• Goodwill - the premium paid over the accounting value of an acquired firm's net assets. Because it owns brands or recipes that have special value.
• FASB requires company test goodwill for impairement at least annualy. Reducing value of goodwill taking a non cash charge on income statement.
• Intangible Assets -other non physical asset that have value - trademarks, copyrights and patents. 
• It losse value over time as get closer to expiration - must be amortized.
• Other Assets -restricted cash,overfund pensions benefits and deferred charges.
• Liabilities
• Obligations of a firm that require settlement at a future date.
• Current Liabilities
• obligations that have maturity date less than 1 year \ business cycle
• Firms must have suffi cient liquidity to cover current liabilities coming due, or
  else they may have to incur more debt to cover the upcoming costs.
• Accounts Payable -credit extended by suppliers to the firm. Paid as invnetory is sold and cash is collected from customers.
• It should fluctuate at a pace comparable to sales. Increasing AP should be accompanied by increasing cost of good sold and inventory.
• AP turnover = Credit Purchase / Avg AP
• Low AR - [1] company is struggling to pay its bulls
• Accured Expenses - Expenses that have been incurred but have not yet been paid. E.g. rent and salaries.
• Unearned revnue -proceeds os sales that have yet to be fullfiled\ services have yet to be rendered.
• Notes payable -short temr funds borrowed from financial institutions. 
• Income tax payable - income tax owed to government
• Current portion of long term debt - the portion of outstanding long term debt that must be paid back within one year. A company must have the resources (cash or issue new debt) to retire this portion of its total debt
• Long-Term Liabilities
• obligations that have maturities that are more than one year
• A company using long-term debt properly can generate value for shareholders.  It can fund expansion projects provides tax deductions through interest payments
  and does not dilute shareholder’s equity.
• However, the amount of long-term debt on a company’s books should be reasonable. The firm must be able to pay back its loans with interest.
• Capital-intensive businesses require more cash - leading to more long-term debt.
• Need to analyze long term debt relative to industry norms.
• Deffered Tax -  different income tax value between 2 accounts - tax purpose vs investors. Firm might use more aggresive depreciation when preparing tax fillings, but use less agreesive methid when reporting to shareholders. .
• Stockholder's Equity
• the net assets that shareholders can lay claim to.
• Additional Paid in Capital -  The difference between par value and the offer price.
• Retained Earnings -  The amount of earnings not returned to owners through dividends. It retained and reinvest back to the business.
• Treasury Stock -  The amount paid for sahres that a company has repurchased. Listed as -ve value because cash was used to purchase theres shares.
• Preferred Stocks -  A hybrid security that companies sell in order to raise capital. it pay regular dividend, but have limited voting power. It have priority over common shares during liquidation
•  It is important to analyze balance sheet trends across a period of time, as well as in relation to major competitors and industry norms.
•  Y-o-Y comparisons is better than Q-o-Q because of seasonal factors. 
• Big orders, sales, initiation of big projects at the end of quarter have impact on quarter fillings.

References:-

• The Balance Sheet: Asset,s Debts and Equity , Z. Joe Lan