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How to Read the Balance Sheet

This statement shows a company's financial position at a specific date. It is important to know how much cash and short-term investments a company has. A company with plenty of cash can invest in future growth, make an acquisition or fund research and development. Large cash positions may indicate a rich cash flow business and conservative management or may indicate upcoming financial difficulty, particularly when seen with increasing payables and shrinking receivables. A large cash amount may make the company a takeover candidate. Generally, it is not desirable to see receivables or inventory growth outpacing revenue growth as it is a warning sign that demand may be weakening. Sharp cuts in bad debt allowances should be examined closely. Slowing sales while inventories pile up is also a red flag for investors. Fixed assets can be overstated or understated but usually relate to core operations. Long-term investments may indicate assets unrelated to the company's basic business. Close attention should be paid to the economic value of goodwill and intangibles.

It is useful to see that payables are kept under control. Dramatic increases in payables may indicate financial stress. Look at the balance sheet in terms of liquidity and debt. Compare current assets and current liabilities to determine if the company has adequate working capital to meet short-term obligations. Look for companies that have greater assets than liabilities. Beware of excessive borrowing as measured by debt ratios. Companies with significant other long-term liabilities should be investigated more closely.

The disparity between the equity and market value of a company reflects the difference between actual and potential earnings power. Therefore, there is no meaningful rule of thumb to measure equity or book value.

Balance Sheet Definitions

Accounts payable - Money owed by a company for goods or services purchased on credit that is payable within one year.

Accounts receivable - Money owed by customers for goods or services purchased on credit for which payment is expected within one year.

Accounts receivable turnover - The ratio of net credit sales to average accounts receivable which is a measure of how quickly customers pay their bills.

Assets - Everything of economic value a company owns.

Asset/equity ratio - The ratio of total assets to shareholders' equity. Measures the degree of protection for long-term creditors and investors.

Balance sheet - A financial statement showing a company's assets, liabilities and shareholders' equity on a given date. Also called the statement of financial condition.

Book value (per share) - Common shareholders' equity divided by common shares outstanding at end of an indicated fiscal period. A much-used basis for evaluating a company's net worth and any changes in it from year to year.

Cash - Includes currency, coins, bank balances, negotiable instruments and cheques.

Cash and short-term investments - Includes cash, short-term investments and marketable securities. Does not include cash held in trust.

Common equity - Total equity less preferred equity, as presented by the company.

Common shares outstanding - The number of common shares outstanding. Includes shares held by subsidiaries and other inter-company holdings. Net of treasury stock.

Common stock - Securities representing ownership in a company. In general, a public corporation has two types of shares, common and preferred. The common shares usually entitle the shareholders to vote at shareholders meetings. The common shares have a discretionary dividend.

Current assets - Value of cash, accounts receivable, inventories, marketable securities and other assets that could be converted to cash in less than one year.

Current liabilities - Amount owed for salaries, interest, accounts payable and other debts due within one year.

Deferred charges - An expenditure that is considered an asset until it becomes relevant to the business at hand, such as prepaid rent that is considered an asset until the rent is officially due.

Deferred liabilities - Revenue that is considered a liability until it becomes relevant to the business at hand, such as a payment received for work that has not yet been performed.

Fixed asset - A tangible long-term asset such as land, building or machinery, held for use rather than for processing or resale.

Inventory - The amount of raw materials, work in progress and finished goods being held for sale at a given time.

Liability - A financial obligation to pay an amount of money, goods or services to another party.

Long-term assets - Value of property, equipment and other capital assets minus accumulated depreciation. It is usually established on a cost basis, and thus does not necessarily reflect the market value of the assets.

Long-term debt - Includes long-term debt, advances, obligations under capital lease, secured debt, mortgages payable and other interest-bearing long-term debt.

Long-term debt/capitalization - Indicator of financial leverage. Shows long-term debt as a proportion of the capital available. Determined by dividing long-term debt by the sum of long-term debt, preferred stock and common stockholder's equity.

Long-term debt-to-equity ratio - A capitalization ratio comparing long-term debt to shareholders' equity. Measures the degree of protection for long-term creditors and investors.

Minority interest - An item in the balance sheet of the parent company representing the portion of the assets of a consolidated subsidiary considered as accruing to the shares of the subsidiary not owned by the parent. Also, an item deducted in the earnings statement of the parent and representing that portion of the subsidiary's earnings considered as accruing to the subsidiary's shares not owned by the parent.

Net assets - The difference between total assets on the one hand and current liabilities and non-capitalized long-term liabilities on the other hand.

Net current assets - The difference between current assets and current liabilities. Also known as working capital.

Net fixed assets - Gross fixed assets less accumulated depreciation, depletion or amortization plus assets under capital lease, deferred exploration and resource development costs and mining and oil and gas interests.

Non-current asset - Any asset that is expected to be held for the whole year, not sold or exchanged, such as real estate, machinery or a patent.

Non-current liability - A liability due within one year.

Other current assets - Value of non-cash assets, including prepaid expenses and accounts receivable, due within one year.

Other long-term liabilities - Value of leases, future employee benefits, deferred taxes, and other obligations not requiring interest payments that must be paid over a period of more than one year.

Other receivables - Includes any receivables other than trade and those from related entities. Includes income taxes receivable, income taxes refundable, current portion of long-term receivables, accrued interest receivable, investment tax credits and subscriptions receivable.

Other equity - Includes contributed surplus, appraisal increase credits, unrealized foreign currency adjustments, loans to employees under management, share purchase plans other items related to common stock. Includes preferred stock purchase funds and warrants outstanding.

Preferred stock - A class of share capital that entitles the owners to a fixed dividend ahead of the company's common shares and to a stated dollar value per share in the event of liquidation. Usually do not have voting rights unless a stated number of dividends have been omitted.

Net worth - Common stockholders' equity which consists of common stock, surplus, and retained earnings.

Quick assets - Cash, marketable securities, and accounts receivable less current liabilities.

Retained earnings - Accounting earnings that are retained by the firm for reinvestment in its operations. Earnings that are not paid out as dividends.

Shareholders' equity - Ownership interest of common and preferred stockholders in a company. The difference between the assets and liabilities of a company which is sometimes called net worth. Equity divided by the number of shares outstanding gives equity per share.

Total asset turnover - The ratio of net sales to total assets. Indicates the effectiveness with which a firm's management uses its assets to generate sales. A relatively high ratio tends to reflect intensive use of assets.

Total capitalization - The total long-term debt and all types of equity of a company that constitutes its capital structure.

Total liabilities - Total of all liability accounts, excluding preferred shares not presented as equity.

Working capital - Defined as the difference between current assets and current liabilities (excluding short-term debt.) Current assets may or may not include cash and cash equivalents, depending on the company.

Working capital ratio - Working capital expressed as a percentage of sales. The higher the ratio, the more liquid the company.

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