Tuesday, 20 April 2010

Financial Statements: The Balance Sheet - 2

In the first part of this post, we looked at most of the contents of a balance sheet, i.e. items listed under assets, and also at current liabilities and working capital. In this part, we look at the remaining items in a typical published balance sheet.

Long-Term Liabilities

Long-term liabilities represent obligations of the company that are payable only after more than one year from the date of the balance sheet. Typically, they will include loans taken to create the long-term assets such as buildings and plant. These loans will usually be repayable over a number of years in agreed installments.

Some companies might issue bonds to the public. Bonds are like shares except in that bondholders are not owners but lenders. They get an agreed rate of interest instead of variable rates of dividends that stockholders receive.

In the example balance sheet, there are items like Deferred tax liabilities under long-term liabilities. These are simply liabilities that are payable after one year or more.

Stockholders' Equity

we have been looking at the assets and liabilities a business so far. If you deduct the liabilities from the assets of a company, you get that company's net worth. This net worth is what we call stockholders' equity. (If the liabilities exceed assets, stockholders' equity is negative; this happens when the company has been incurring losses and the accumulated losses exceed the money contributed by shareholders.)

Stockholders' equity is not a single item in the balance shset. Instead, it is usually represented by several items, such as preferred stock, common stock and retained earnings. Preferred stock is something between bonds and common stock, typically receiving a fixed rate of dividend if profits to pay the dividend are available. Common stockholders are what we typically mean when we speak of company shareholders.

All stock typically have a "par" value which is simply a book value. Stockholders typically pay much more than this par value to acquire shares from the company, and the excess amount over par value is shown as Additional Paid In Capital.

Companies might also purchase their own shares in the market and either retire (eliminate) them, or keep them in reserve for later reissue. Thus companies might purchase shares when their market price is low, and reissue them when the price is high. If the shares are not retired, the balance sheet will disclose the repurchased shares as Treasury Stock, and show them as a deduction from the Stockholders equity.

The example balance sheet shows all the above cases, viz. preferred stock, common stock with par value, additional amounts paid in by shareholders and treasury stock.

The major item remaining under stockholders' equity is retained earnings. Retained earnings represent accumulated profits. Profits earned by the company can either be distributed as dividends to shareholders, or retained in the company to finance expansion or meet shortfalls in working capital.

The cumulative amount of such retained earnings is what we will see as Retained Earnings under stockholders' equity. Where the company has been incurring losses, the retained earnings figure will be Retained Deficit, a negative value that is deducted from stockholders' equity, as is the case in the example balance sheet.

Now that we have looked at the assets, liabilities and stockholders' equity, we will discuss balance sheet analysis in the next post. Balance sheet analysis can reveal very significant information about the company's financial position.


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