Finance for non finance-I
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19-10-2010, 05:38 PM

.ppt   understanding balance sheet.ppt (Size: 482 KB / Downloads: 78)
Finance for non finance-I

• How the Balance Sheet Works

• The balance sheet is divided into two parts that, based on the following equation, must equal each other, or balance each other out. The main formula behind balance sheets is:

Assets = Liabilities + Shareholders' Equity
• Assets, liabilities and owner’s equity
• Assets are what a company uses to operate its business,
• liabilities and equity are two sources that support these assets.
• Owners' equity, referred to as shareholders' equity in a publicly traded company, is the amount of money initially invested into the company plus any retained earnings, and it represents a source of funding for the business.

It is important to note that a balance sheet is a snapshot of the company’s financial position at a single point in time.
• Types of Assets
• Current Assets
Current assets have a life span of one year or less, meaning they can be converted easily into cash. Such assets classes include cash and cash equivalents, accounts receivable and inventory
• Non-Current Assets
• Non-current assets are assets that are not turned into cash easily, are expected to be turned into cash within a year and/or have a life-span of more than a year.
• They can refer to tangible assets such as machinery, computers, buildings and land.
• Non-current assets also can be intangible assets, such as goodwill, patents or copyright.
• What are Liabilities?
• On the other side of the balance sheet are the liabilities. These are the financial obligations a company owes to outside parties. Like assets, they can be both current and long-term.
• Long term liabilities
• Long-term liabilities are debts and other non-debt financial obligations, which are due after a period of at least one year from the date of the balance sheet.
• Current liabilities

• Current liabilities are the company’s liabilities which will come due, or must be paid, within one year.
• This includes both shorter term borrowings, such as accounts payables, along with the current portion of longer term borrowing, such as the latest interest payment on a 10-year loan.
• Shareholders' Equity

• Shareholders' equity is the initial amount of money invested into a business.
• If, at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet into the shareholder’s equity account.
• This account represents a company's total net worth.
• In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders' equity on the other.
• If, at the end of the fiscal year, a company decides to reinvest its net earnings into the company (after taxes), these retained earnings will be transferred from the income statement onto the balance sheet into the shareholder’s equity account.
• This account represents a company's total net worth.
• In order for the balance sheet to balance, total assets on one side have to equal total liabilities plus shareholders' equity on the other.
• Components of Shareholder's Equity
Also known as "equity" and "net worth", the shareholders' equity refers to the shareholders' ownership interest in a company.
Usually included are:

• Preferred stock - This is the investment by preferred stockholders, which have priority over common shareholders and receive a dividend that has priority over any distribution made to common shareholders. This is usually recorded at par value.
• Additional paid-up capital (contributed capital) - This is capital received from investors for stock; it is equal to capital stock plus paid-in capital. It is also called "contributed capital".
• Common stock - This is the investment by stockholders, and it is valued at par or stated value.
• Retained earnings - This is the total net income (or loss) less the amount distributed to the shareholders in the form of a dividend since the company's initiation.
• Assets = Liabilities + Shareholders' Equity: implications…
• The meaning of this equation is important. Generally sales growth, whether rapid or slow, dictates a larger asset base - higher levels of inventory, receivables and fixed assets (plant, property and equipment). As a company's assets grow, its liabilities and/or equity also tends to grow in order for its financial position to stay in balance.
• How assets are supported, or financed, by a corresponding growth in payables, debt liabilities and equity reveals a lot about a company's financial health. For now, suffice it to say that depending on a company's line of business and industry characteristics, possessing a reasonable mix of liabilities and equity is a sign of a financially healthy company. While it may be an overly simplistic view of the fundamental accounting equation, investors should view a much bigger equity value compared to liabilities as a measure of positive investment quality, because possessing high levels of debt can increase the likelihood that a business will face financial troubles.
• Sample balance sheets
• Understanding it!

• As you can see from the balance sheet above, it is broken into two sides. Assets are on the left side and the right side contains the company’s liabilities and shareholders’ equity. It is also clear that this balance sheet is in balance where the value of the assets equals the combined value of the liabilities and shareholders’ equity.
• Another interesting aspect of the balance sheet is how it is organized. The assets and liabilities sections of the balance sheet are organized by how current the account is. So for the asset side, the accounts are classified typically from most liquid to least liquid. For the liabilities side, the accounts are organized from short to long-term borrowings and other obligations.
• What Does Prepaid Expense Mean?

• Due to the nature of certain goods and services, they must be prepaid expenses. For example, insurance is a prepaid expense, because the purpose of purchasing insurance is to buy proactive protection in case something unfortunate happens. Clearly, no insurance company would sell insurance that covers the occurrence of an unfortunate event, after the fact, so insurance expenses must be pre-paid.
• An example of expensing prepaid expenses would be if a company had a one-year insurance policy cost of Rs.1200. As each month elapses, Rs.100 of prepaid insurance would be expensed to the income statement until the account is empty at the end of the year.
• What Does Accumulated Depreciation Mean?

• A company buys an asset for Rs.5,000 that has a five-year lifespan and zero salvage value. The company uses straight-line depreciation, and the asset depreciates at a rate of Rs.1,000 per year.
• In year one, depreciation will be Rs.1,000, as will accumulated depreciation, and carrying value of the asset will be Rs.4,000.
• In year two, depreciation will be Rs.1,000, accumulated depreciation will be Rs.2,000 (Rs.1,000 from the current year + Rs.1,000 accumulated from previous years) and carrying value will be Rs.3,000.
• Amortization

• Suppose XYZ Biotech spent $30 million dollars on a piece of medical equipment and that the patent on the equipment lasts 15 years, this would mean that $2 million would be recorded each year as an amortization expense.
• While amortization and depreciation are often used interchangeably, technically this is an incorrect practice because amortization refers to intangible assets and depreciation refers to tangible assets.
• Deferred Charge

• Recording deferred charges in this manner ensures that a company is adhering to Generally Accepted Accounting Principles (GAAP) by matching revenues with expenses.
• A prime example of a deferred charge is rent. Consider the case where a company pays a lump sum to its landlord to cover six months' rent. As each month approaches, the company will use a portion of the funds from its deferred charges account and recognize this portion as an expense on its financial statements. This process ensures that revenues for the month are matched with the expenses incurred for that month.
• What Does Accrued Liability Mean?

• An accounting term for an expense that a business has incurred but has not yet paid. A company can accrue liability for any number of items, such as a pension account that will pay retirees in the future. Accrued liabilities can be recorded as either short or long-term liabilities on a company's balance sheet.


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