Balance Sheet Review Dr Craig Ruff Department of
Balance Sheet Review Dr. Craig Ruff Department of Finance J. Mack Robinson College of Business Georgia State University © 2014 Craig Ruff 1
Balance Sheet… Balance sheet is a summary statement of what the company owns and owes at a specific point in time. ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity 2
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities As with the basic income statement, you need to make sure that this basic balance sheet is firmly in your mind. Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity 3
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity • Remember: It is a balance sheet: the two sides have to balance. Total Assets = Total Liabilities + Shareholders’ Equity • Remember: It is a stock measure; it is a picture at one point in time. • Remember: Generally, the items on the balance sheet are listed in order of liquidity. 4
Assets © 2014 Craig Ruff 5
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets A demand deposit is an account at a financial institution (bank, savings and loan, credit union, etc. ) that can be withdrawn immediately. In other words, you do not have to give your bank advance notice that you are withdrawing the money. Cash is the most liquid asset. Often, it is mainly in the form of demand deposits at banks. Cash may be ‘restricted’ (loan covenants), ‘spent’ (declared dividends) or ‘non-US. ’ Cash might also include very-short term securities (T-bills, commercial paper). (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff 6
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Net Accounts Receivable occur when a company sells a product but has not yet received the cash from the customer. Simply put, the accounts receivable represent money owed to the company by customers. Total Current Assets Net Accounts Receivable = Gross AR – Allowance for Doubtful Accounts. Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff 7
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Inventories Generally take three forms: raw materials, work in process, finished goods. Also, the different costing approached (such as FIFO, LIFO and average cost) lead to different COGS and inventory values on the balance sheet. Here, we generally won’t worry about the different types of inventory. And we typically just use the straight-line form of depreciation. Net Fixed Assets Total Assets © 2014 Craig Ruff 8
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets Total Current Assets are referred to as ‘current’ assets as they are generally expected to be converted into cash within one year. (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff 9
Balance Sheet… ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff Fixed Assets includes equipment, building, vehicles, etc. that are generally of a permanent nature and required for the operation of the business. For this class: Gross Fixed Assets is the original historic cost of the asset. Accumulated Depreciation is nicely named: it is the depreciation that has accumulated on the asset to that point. Net Fixed Assets represents what the asset is really worth from an accounting perspective. We would refer to this as the ‘book value’ of the assets. 10
Suppose the company buys a metal lathe for $1, 000. The lathe is expected to have a useful life of five years and zero salvage value. © 2014 Craig Ruff 11
Suppose the company buys a metal lathe for $1, 000. The lathe is expected to have a useful life of five years and zero salvage value. t=0 Day it is Purchased Annual Depreciation Expense Gross Fixed Accumulated Depreciation Net Fixed © 2014 Craig Ruff $1, 000, 000 12
Suppose the company buys a metal lathe for $1, 000. The lathe is expected to have a useful life of five years and zero salvage value. t=0 Day it is Purchased Annual Depreciation Expense Gross Fixed Accumulated Depreciation Net Fixed © 2014 Craig Ruff t=1 End of One Year $200, 000 $1, 000, 000 $200, 000 $1, 000 $800, 000 13
Suppose the company buys a metal lathe for $1, 000. The lathe is expected to have a useful life of five years and zero salvage value. t=0 Day it is Purchased Annual Depreciation Expense Gross Fixed Accumulated Depreciation Net Fixed © 2014 Craig Ruff $1, 000, 000 t=1 End of One Year t=2 End of Two Years $200, 000 $1, 000, 000 $200, 000 $400, 000 $800, 000 $600, 000 14
Suppose the company buys a metal lathe for $1, 000. The lathe is expected to have a useful life of five years and zero salvage value. t=0 Day it is Purchased Annual Depreciation Expense Gross Fixed Accumulated Depreciation Net Fixed © 2014 Craig Ruff $1, 000, 000 t=1 End of One Year t=2 t=3 t=4 t=5 End of Two End of Three End of Four End of Five Years $200, 000 $200, 000 $1, 000, 000 $1, 000 $200, 000 $400, 000 $600, 000 $800, 000 $1, 000 $800, 000 $600, 000 $400, 000 $200, 000 $0 15
Liabilities and Equity © 2014 Craig Ruff 16
ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity 17
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Notes Payable often represent short-term borrowing from a bank, perhaps to fund accounts receivable and inventory. Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff 18
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Accounts Payable represent purchases by the company that the company has not yet paid for. Since this is money owed by the company to its suppliers, it is a ‘debt’ and a liability. Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff 19
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff Accrued Expenses represent expenses that have been ‘expensed’ on the income statement but not yet paid for by the company by the end of the closing period. As an example, suppose a company pays its employees in early January for work they did in the last two weeks of December. At the end of the year (December 31), the accountant will ‘close out the books’ and record the (notyet-paid) wages as an expense on the annual income statement. Since the wages have been ‘accrued’ and not yet paid, the accountant will reflect the company’s obligation (debt) to the employees as an accrued expense on the balance sheet (in, say, ‘wages payable’). When the company actually pays the employees in January, the accountant will lower cash (on the asset side) and lower wages payable on liability side. 20
Suppose a company’s employees have generated $10, 000 of wage expense in the last two weeks of December. It is now, December 31 st… © 2014 Craig Ruff 21
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Current Portion of Long-Term Debt represents the portion of long-term debt due within one year. Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff 22
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities are generally expected to be paid off in one year. Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff 23
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities Long-Term Debt represents liabilities that mature in excess of one year. EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff 24
Balance Sheet… LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff Preferred Stock is a form of equity that has both debtand equity-like features. Often, it is described as a “hybrid. ” Common Stock represents the owners’ initial investment in the company. Retained Earnings represent the cumulative total of all net income that has been reinvested in the company. 25
Balance Sheet… EQUITY Preferred Stock Common Stock at Par Additional Paid in Capital Retained Earnings Total Liabilities and Equity EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Common Stock is often broken into two pieces: 1) Common stock at par 2) additional paid in capital This division into two pieces is artificial and meaningless; it is the sum of the two pieces that matters. It is the sum of the two pieces that represents the book value of the owners’ initial investment. © 2014 Craig Ruff 26
Suppose Wow Co. is a brand new company and issues 100, 000 shares of common stock (‘equity’) at a price of $10 per share. Also, the par value of each new share is $2. Amount of Dollars Raised by the Company by Issuing the New Equity © 2014 Craig Ruff $1, 000 (100, 000 new shares times $10 per share = $1, 000) 27
Suppose Wow Co. is a brand new company and issues 100, 000 shares of common stock (‘equity’) at a price of $10 per share. Also, the par value of each new share is $2. Accounting Treatment: Common Stock Additional Paid in Capital © 2014 Craig Ruff $200, 000 $800, 000 Common Stock: $200, 000 = $2 par share par value * 100, 000 shares. Additional Paid in Capital: $1, 000 in money raised less the $200, 000. 28
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company Net Income Dividends Retained Earnings © 2014 Craig Ruff 29
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company t=1 End of Year 1 Net Income Dividends $1, 000 $0 Retained Earnings $1, 000 © 2014 Craig Ruff 30
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company t=1 t=2 End of Year 1 End of Year 2 Net Income Dividends $1, 000 $0 $3, 000 $0 Retained Earnings $1, 000 $4, 000 © 2014 Craig Ruff 31
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company t=1 t=2 t=3 End of Year 1 End of Year 2 End of Year 3 Net Income Dividends $1, 000 $0 $3, 000 $0 $4, 000 $500, 000 Retained Earnings $1, 000 $4, 000 $7, 500, 000 © 2014 Craig Ruff 32
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company t=1 t=2 t=3 t=4 End of Year 1 End of Year 2 End of Year 3 End of Year 4 Net Income Dividends $1, 000 $0 $3, 000 $0 $4, 000 $500, 000 -$2, 000 $500, 000 Retained Earnings $1, 000 $4, 000 $7, 500, 000 $5, 000 © 2014 Craig Ruff 33
Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… t=0 Start of Company t=1 t=2 t=3 t=4 t=5 End of Year 1 End of Year 2 End of Year 3 End of Year 4 End of Year 5 Net Income Dividends $1, 000 $0 $3, 000 $0 $4, 000 $500, 000 -$2, 000 $500, 000 $1, 000 $750, 000 Retained Earnings $1, 000 $4, 000 $7, 500, 000 $5, 250, 000 © 2014 Craig Ruff 34
Finally, suppose that Wow Co. does not issue any more new stock or buy back any existing stock over the next few years… t=0 Start of Company Net Income Dividends Common Stock Additional Paid in Capital Retained Earnings © 2014 Craig Ruff t=1 t=2 t=3 t=4 t=5 End of Year 1 End of Year 2 End of Year 3 End of Year 4 End of Year 5 $1, 000 $0 $3, 000 $0 $4, 000 $500, 000 -$2, 000 $500, 000 $1, 000 $750, 000 $200, 000 $200, 000 $800, 000 $800, 000 $1, 000 $4, 000 $7, 500, 000 $5, 250, 000 35
Finally, suppose that Wow Co. does not issue any more new stock or buy back any existing stock over the next few years… t=0 Start of Company Net Income Dividends Common Stock Additional Paid in Capital Retained Earnings Total Book Value of Common Stock © 2014 Craig Ruff t=1 t=2 t=3 t=4 t=5 End of Year 1 End of Year 2 End of Year 3 End of Year 4 End of Year 5 $1, 000 $0 $3, 000 $0 $4, 000 $500, 000 -$2, 000 $500, 000 $1, 000 $750, 000 $200, 000 $200, 000 $800, 000 $800, 000 $1, 000 $4, 000 $7, 500, 000 $5, 250, 000 $2, 000 $5, 000 $8, 500, 000 $6, 250, 000 $1, 000 36
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