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“Old accountants never die; they just lose their balance.”
ANONYMOUS


The Agile Manager reflected on his lessons with Steve. Days
one and two had been a bit rough. It took the first day just to wear
down his resistance to numbers in general, and the second day for
him to be able to define, acceptably, things like cost of goods
sold. He was dreading today™s session, in which they™d tackle the
balance sheet.
But it went better than he thought. Towards the end of the ses-
sion, Steve punched a few numbers into a calculator. “So the book
value of the company is $24 per share. Equity divided by the
number of shares, right?” He looked up. The Agile Manager nod-
ded. “But our stock price is $79. How can that be?”
“Aha! You know the stock price. You can™t be too oblivious to
numbers.” The Agile Manager jabbed Steve in the ribs playfully.
“Of course I do,” said Steve. “A good part of my retirement plan
is invested in the company™s stock.”


27
28 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS


The Agile Manager said, “Market price is usually higher than
book value. That™s the way it is with a publicly traded company. In
our case, people aren™t buying shares in what we have. They are
buying shares in what they think we will become in the future”a
bigger company with increasing revenues and profits.”
“Still,” said Steve, “book value bears some relationship to mar-
ket value, don™t you think? If only as a reference point?”
“Yep. And you know what? You™re already starting to talk like
an old pro . . .”

A balance sheet fleshes out what accountants call the “basic
accounting equation”:
ASSETS = LIABILITIES + OWNER™S EQUITY
Each part of this equation can be defined simply:
Assets are anything of value that a company owns, like cash,
accounts receivable, inventory, buildings, or equipment.
Liabilities are what the company owes to creditors. In plain
language, they™re debts. But referring to them as “liabilities”
sounds more weighty and profound and helps accountants pol-
ish their erudite image as they bill you $100 per hour to inter-
pret this stuff. (“Liabilities? Well, we . . . [ahem] we might think
of them as financial obligations
BT of the firm.They™re amounts, that
est
ip is, sums of money, that the com-
pany owes to outside parties. I
The balance sheet freezes the
suppose you might call them
company™s account balances
debts. That™ll be $100.”)
at a single point in time. The
Owner™s equity (or net worth) is the
balance sheet can be obso-
stake or interest that the owners
lete the very next day.
have in the company. In a corpo-
ration, owner™s equity is called
stockholders™ equity. If the company is a partnership, it would be
partners™ equity. If the business is a sole proprietorship (which
means it™s owned by one guy or gal), owner™s equity could also
be called capital or net worth. Remember what we said back in
29
Understand the Balance Sheet


chapter two about several accounting terms meaning the same
thing? Told ya!

Balance Sheet: Distinguishing Features
What makes a balance sheet different from an income state-
ment? For one thing, it doesn™t
BT
summarize information for cer- est
ip
tain accounts as the income state-
ment does.
A service business will most
Rather, a balance sheet is a
likely not have an inventory of
“snapshot” statement. The com-
any of value.
pany is frozen on the date shown
at the top, and the balances in its
balance sheet accounts are shown on that specific day” typi-
cally the last day of the month or year.
Most of the accounts on a balance sheet have at least one
thing in common: Their balances fluctuate a little bit every day
because of the day™s business activities. Also, the balances in a
company™s balance sheet accounts run perpetually. In contrast,
the balances in the income statement accounts (sales, expenses,
purchases, and freight, for example) are reset to zero or “closed
out” at the beginning of the new financial year.
Figure 3-1 on the following page shows the balance sheet for
Avaricious Industries.

Up Close and Personal With a Balance Sheet
Let™s carve out the main sections of A.I.™s balance sheet and
look at them closer.
Assets. Again, these are anything of value that the company
owns. That includes cash, accounts receivable from customers
that the business has sold to on credit, the coffee machine that™s
always breaking down in the break room, and that $2 million
Picasso hanging in the CEO™s office. Assets are typically broken
down into “current assets” and “property and equipment.”
Current assets are cash, things that will be converted into cash
30 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS


Figure 3-1 Avaricious Industries
Balance Sheet
December 31, 19XX

ASSETS
Current assets
Cash and cash equivalents $1,271,231
Accounts receivable 1,032,409
less allowance for
doubtful accounts 38,000 994,409
Notes receivable 350,000
Merchandise inventories 3,250,000
Total current assets 5,865,640
Property and equipment 17,841,980
Less accumulated depreciation 4,173,130
Net property and equipment 13,668,850
TOTAL ASSETS $19,534,490
LIABILITIES
Current liabilities
Accounts payable 1,275,300
Salaries payable 330,000
Income taxes payable 925,239
Other accrued expenses 8,000
Total current liabilities 2,538,539
Long-term liabilities
Mortgage payable 500,000
Bonds payable 2,400,000
Total long-term liabilities 2,900,000
TOTAL LIABILITIES 5,438,539
STOCKHOLDERS™ EQUITY
Common stock, 2,500,000 shares
at $1 par value per share 2,500,000
Capital in excess of par value 1,750,000
Retained earnings, January 1, 8,386,350
Net income for year 1,509,601
Less dividends (50,000)
Retained earnings, December 31, 19xx 9,845,951
TOTAL STOCKHOLDERS™ EQUITY 14,095,951
TOTAL LIABILITIES AND
STOCKHOLDERS™ EQUITY $19,534,490
31
Understand the Balance Sheet


within a year (such as accounts receivable and the current por-
tion of any notes receivable), and inventory, which turns into
cash when it™s sold. Keep looking at the asset section of the
balance sheet as we investigate these items in detail.
Cash and cash equivalents. This is the balance in the company™s
checking account(s), plus highly liquid short-term or tempo-
rary investments (sometimes called “marketable securities”).These
might include certificates of deposit, stocks, and corporate or
U.S. government bonds, all investments that the company could
probably sell with a telephone call to its bank or brokerage firm.
They were initially bought to keep excess cash working instead
of leaving it to gather dust in a non-interest-bearing checking
account.
Accounts receivable and notes receivable. Accounts receivable are
owed to the company by customers to which it sold goods or
services on credit. Notes receivable are promissory notes that
the company will collect in less than a year. (Notes receivable
due in more than a year would be listed as a long-term asset.)
Notice that the total accounts receivable balance is reduced
by an allowance for doubtful accounts. That™s the accountant™s
practical side at work, telling you that the business probably won™t
collect all of those accounts.
In a big business that has literally hundreds if not thousands
of credit customers, some will inevitably turn out to be dead-
beats or go bankrupt. So the accountants estimate what per-
centage of the company™s receivables will turn sour and subtract
that amount. The result is a realistic net amount that the com-
pany expects (crossing its fingers) to collect.
Merchandise inventories. If the company is a retailing or whole-
saling business, this is the value of products that the company
has bought and intends to resell for a profit. In a manufacturing
business, inventories include finished goods that are sitting in
the warehouse as well as goods in process (those in various stages
of completion), raw materials, and parts and components that
will go into the end product.
32 THE AGILE MANAGER™S GUIDE TO UNDERSTANDING FINANCIAL STATEMENTS


You can calculate the value of a company™s inventory using
one of four methods. Sit tight; there™ll be more about this in
chapter six.
The second category of assets, property and equipment, are,
well, property and equipment. The business uses them to make
the product or provide the service that it sells.
Land, buildings, machinery, and equipment fall under this head-
ing. They™re shown at the cost the
BT est company paid to buy or build
ip them (including such expenses as
installation costs and taxes) mi-
Liabilities and stockholders™
nus the amount that they™ve de-
equity represent claims against
a company™s assets. That™s why preciated since they were bought
or built.
the balance sheet balances.
Depreciation can be plain old
wear-and-tear, technological ob-
solescence”the kind that makes the computer you paid $3,500
for last year worth $800 today”or both.
Land isn™t depreciated, by the way, because you never use it
up and they aren™t making any more of it. Raw land is shown on
the balance sheet at its purchase price and neither appraised nor
depreciated as years go by. If the land and the building are even-
tually sold, the difference between the land™s cost and what was
received on the sale would be recorded as a gain (if greater than
cost) or loss (if less than cost) on sale of plant and equipment.
Some companies may have other categories of assets too, in-
cluding intangible assets such as patents and copyrights. Current
assets and P&E are the two major players, however.
Liabilities. This section, which we™ll reproduce here as Fig-
ure 3-2 to save you from having to flip back a page, shows all the
debts the company owes to creditors of every kind. Even em-
ployees are creditors of the company on the balance sheet date,
because it owes them salaries that won™t be paid until payday.
Current liabilities are bills the company must pay within the
next twelve months. Long-term liabilities are bills that will come
33
Understand the Balance Sheet


Figure 3-2
Current Liabilities
Accounts payable $1,275,300
Salaries payable 330,000
Income taxes payable 925,239
Other accrued expenses 8,000
Total current liabilities 2,538,539
Long-term liabilities
Mortgage payable 500,000
Bonds payable 2,400,000
Total long-term liabilities 2,900,000
TOTAL LIABILITIES $5,438,539

due in more than one year. As Figure 3-2 shows, A.I. owes
$500,000 on a mortgage and $2,400,000 on bonds that it sold
to raise funds. Total liabilities? Almost $5.5 million.
Stockholders™ Equity. This section shows what the company
is worth to its owners”those optimistic, hopeful stockholders,
including widows, orphans, and retirees living on Social Secu-
rity, who risked their life savings to cast their lot with the future
of Avaricious Industries.
As Figure 3-3 shows, Avaricious Industries has sold 2,500,000
shares of stock. Management used the money it got from stock
sales (along with what it borrowed by issuing bonds) first to
start and then expand the business.
You™ll notice that A.I.™s stock has a “par value” of $1.00 per
share. That™s an arbitrary figure that has nothing to do with what
Figure 3-3
Common stock, 2,500,000 shares
at $1 par value per share 2,500,000
Capital in excess of par value 1,750,000
Retained earnings, January 1, 8,386,350

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