We come into this world head first and go out feet first; in between, it is all a matter of balance.

Transcription

1 ENGM 401 & 620 X1 Fundamentals of Engineering Finance Fall 2010 Lecture 10: The Balance Sheet We come into this world head first and go out feet first; in between, it is all a matter of balance. - Paul Boese M.G. Lipsett University of Alberta Income Income Statements Statements Review Review True or False: Net Income is given to the owners as a dividend or applied to repay existing loans. True or False: Cash break-even occurs at a lower operating income than book break-even. True or False: Depreciation is the only non-cash expense that is a source of cash. True or False: If a one-time revenue is included in operating income, it creates a distortion of the actual margin in the reporting period. True or False: Retained Earnings is the incremental value added during a reporting period. MG Lipsett,

2 The The Balance Balance Sheet Sheet A balance sheet is a snapshot of a business s financial position at a point in time (usually the last day of the accounting period) Also called a position statement The balance sheet balances a business s assets against its liabilities, and owner s equity: Assets = Liabilities + Equity Assets include current assets and fixed assets Liabilities include current liabilities and long-term liabilities Owner s equity includes shares and retained earnings (Sometimes you ll see Assets = Liabilities with Equity as a special type of Liability) MG Lipsett, Elements Elements of of the the Balance Balance Sheet Sheet Current assets expected to be converted to cash within 1 year or less receivables, inventory, work in progress, etc. and cash itself Fixed assets difficult to convert to cash without affecting core operations equipment, land, buildings New and used (depreciated) Long-Term investments Maturity > 1 year Goodwill premium paid to buy another company Intangibles (non-physical assets) MG Lipsett, Current liabilities to be paid within 1 year or less taxes due, interest due, salaries, accounts payable to suppliers, etc. and short-term line of credit Long-term liabilities liabilities not expected to draw on current assets loans, issued bonds Shares (Equity) Total proceeds from: Par Value of shares in the company &/or provided to company by owners Retained earnings running total of all earnings minus dividends 2

3 Balance Balance Sheet Sheet Format Format Assets: Current: Cash Receivables (Promise to be paid) Short Term Notes Inventory (often as days of sales) Prepaid Expenses Liabilities: Current: Short Term Credit Line Accounts Payable (Promise to pay) Accrued Expenses (e.g. wages owed) Taxes Payable Current Portion of Long-Term Debt Fixed: Land, Bldgs & Eqpmnt less Accum. Depreciation Long Term Investments Goodwill Intangible Assets = Long Term: Long-Term Debt Repayable Grants Shareholder s Equity: Capital Shares Retained Earnings MG Lipsett, Balance Balance Sheet Sheet Format Format Assets: Current: Cash More Liquidity Liabilities: Current: Short Term Credit Line Receivables Short Term Notes Inventory Prepaid Expenses Accounts Payable Accrued Expenses Taxes Payable Curr. Port. Of L-T Debt Fixed: Land, Bldgs & Eqpmnt minus accumulated Depreciation Long Term Investments Goodwill and Intangible Assets Long Term: Long Term Debt Repayable Grants Shareholder s Equity: Capital Shares Retained Earnings MG Lipsett,

4 Sample Sample Balance Balance Sheet Sheet #1 #1 (e.g. WIP) Estimated expenses not deductible until future Source: MG Lipsett, Sample Sample Balance Balance Sheet Sheet #1 #1 (2) (2) Source: MG Lipsett,

5 Sample Sample Balance Balance Sheet Sheet #2 #2 Source: MG Lipsett, Balance Balance Sheets: Sheets: Notes Notes Assets If the asset is useful, it is recorded at book value the lesser of original cost minus depreciation or market value Higher market value is never recognized in advance If it is useless or worn out, it is written off Depreciation & writedowns Accounting is always conservative During high inflation, book values deviate from real values (recall our discussion on real estate) Some long-term assets are intangible Intangibles can depreciate too (e.g. patents with limited lifetimes) MG Lipsett,

6 Balance Balance Sheets: Sheets: Notes Notes (2) (2) Typically use a one-year rule for current assets and liabilities List assets in order of liquidity Cash at top, then receivables, and so on Prepaid expenses are bills paid annually but tracked monthly or quarterly Fixed assets usually list the purchase value as well as an accumulated depreciation as a reduction This gives the ability to have a sense of the age of the assets. Capital shares (cash injection) are distinguished from retained earnings (cash retention) Goodwill premium paid to purchase a company purchase price minus the book value of the business can depreciate MG Lipsett, Balance Balance Sheets: Sheets: Notes Notes (3) (3) Equity Minority interest is the value of minority shareholder s holding in a subsidiary or ownership that is less than 50% of outstanding. (revenue and expenses from minority shares are sometimes reported on the income statement) Preferred shares Additional rights Obligations before dividends go to common shareholders Claim on liquidation proceeds Voting rights Not guaranteed dividends Not premium dividends Common stockholders only get a residual claim on proceeds if company is sold off Preferred shares are less risky than regular equity (common stock); but more risky than just lending money to a company MG Lipsett,

7 Credit Credit Issues Issues Receivables represent value that you have, in effect, lent to others (your customers) Liabilities represent value that you have, in effect, borrowed from others Creditworthiness is a key issue throughout: You check the credit rating of your customers Your suppliers check your credit rating Your short term lender focuses on the quality of your current assets Your long term lender usually has the right to take over assets that securitize the loan Certain government charges transfer to board members MG Lipsett, Order Order of of Creditors Creditors If the business goes into receivership, there is an order in which creditors are paid when assets are liquidated: 1. Short term lender Covenants: conditions on access to funds Not typically secured (tied to specific assets) 2. Suppliers 3. CRA 4. Other creditors with secured debt Terms that tie up assets 5. Other creditors 6. Owners Equity has potentially high return But debt has lower risk MG Lipsett,

8 Working Working Capital Capital Working capital (WC) is the difference between current assets (CA) and current liabilities (CL) The extra cost of being in business over and above fixed assets A good measure of a company's efficiency and its financial health Working capital = current assets current liabilities (balance sheet #1: = 1612) Working capital ratio is current assets divided by current liabilities Working capital ratio = current assets / current liabilities (balance sheet #1: 4615 / 3003 = 1.54) Adequacy of working capital is one key test for the provision of a short term credit line by a bank Positive working capital means you can pay off your short-term liabilities Negative working capital means you can t meet your short-term liabilities with your current assets MG Lipsett, Working Margin Working Example Capital Capital (2) #3 (2) MG Lipsett, Money that is tied up in inventory or money that customers still owe to the company can t be used to pay off any of its obligations If CA & CL both go down same amount, then WC stays the same. In contrast, reducing receivables and inventory is a good way to reduce current liability. Working capital generally increases with sales level Typically, inventory, payables and receivables are proportional to sales Failure to recognize this has sunk many a business! Inventory and receivables are often measured in terms of days As a ratio of daily sales Often in the range of 30 to 60 days of sales revenue More businesses fail for a lack of available cash than for a lack of profit 8

9 Summary Margin Summary Example #3 A balance sheet is a snapshot of a business s financial position at a point in time (usually the last day of the accounting period) Assets = Liabilities + Equity Assets include current assets and fixed assets Liabilities include current liabilities and long-term liabilities Working capital = current assets - current liabilities The extra cost of being in business over and above fixed assets A good measure of a company's efficiency and its financial health Working capital ratio = current assets / current liabilities Adequate working capital is very important for short-term credit from a bank MG Lipsett, Review Review of of Material Material for for Midterm Midterm #1` Chapters 1, 2, 3; Chapter 4.1 & 4.2 Lectures 1 to 10 inclusive Posted handouts (guide to calculations, examples, FAQ, etc.) Open-book, open notes Paper-based reference material only Midterm has 20 multiple-choice and 25 true-false questions Midterm is in-class, 50 minutes in duration Both Scantron sheet and exam paper must be handed in Calculators are allowed (calculations are not complicated) Communication features of devices must be off MG Lipsett,

10 Tips Tips for for the the Midterm Midterm Read the questions carefully and pick the BEST answer Don t rely on looking things up There won t be much time for reading notes during the test Know where to find information to check your answers Make summary revision notes Mark relevant sections in text and lecture notes Review the calculation methods and where they apply Mark your answers on the exam booklet and then transfer them to the Scantron sheet Note: only the Scantron sheet gets marked!! First do the questions that are easy, then do the rest Do the sample midterm to practice MG Lipsett,