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Balance Sheetby Binam Ghimire

Learning Objectives

1. The Finance Decision2. The Investment Decision3. The Recognition of Items in the Balance Sheet4. IAS1 Presentation of The Balance Sheet5. Analysis of the Financial Position

Introduction

Two important decisions in Business are:The Financing Decision andThe Investment Decision

What are these ?

The Finance Decision The Type and Amount of Finance to raise.

Long Term FinanceEquity, e.g.

• Ordinary• Preferred

Debt, e.g.• Bonds• Loans

Short Term Finance (repayable within 1 year)Bank OverdraftTrade Creditors/Accounts Payable

Organisations raise finance to fund investment

The Investment Decision

Which Assets to buyLong Term (Non Current Assets)

Land & BuildingsEquipmentEtc

Short Term (Current Assets)InventoryBankCash

The Balance Sheet

The Balance Sheet brings the Finance & Investment Decisions together to present a Statement of the Financial Position as at a certain date.

Let’s start by looking at a very simple example…

Balance Sheet of F Clothes UK as at 31st December 20xx. Non Current AssetsLand & Buildings 100,000 Capital

500,000Fixtures 20,000 + Net Profit 3,000

120,000 503,000Non Current LiabilitiesBank Loan 30,000

Current Assets Current LiabilitiesInventory 10,000 Accounts Payable

75,000Accounts Rec 120,000Bank 358,000

488,000 608,000 608,000

Investment Decisions = Finance Decisions

Non Current Assets Equity+ +

Current Assets Non Current Liabilities+

Current Liabilities

Balance Sheet of F Clothes UK as at 31st December 20xx. Non Current AssetsLand & Buildings 100,000 Capital

500,000Fixtures 20,000 + Net Profit 3,000

120,000 503,000Non Current LiabilitiesBank Loan 30,000

Current Assets Current LiabilitiesInventory 10,000 Accounts Payable

75,000Accounts Rec 120,000Bank 358,000

488,000 608,000 608,000

What does this tell you about the Finance & Investment Decisions ?

Balance Sheet Definitions Asset.

An asset is a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise.

Liability. A liability is a present obligation of the

enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

What about Off Balance Sheet Finance? Equity.

Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.

Recognition of the Elements of Financial Statements

Recognition is the process of incorporating in the balance sheet (or income statement) an item that meets the definition of an element and satisfies the following criteria for recognition: An asset

when it is probable that the future economic benefits will flow to the enterprise and the asset has a cost or value that can be measured reliably.

A liability when it is probable that an outflow of resources

embodying economic benefits will result from the settlement of a present obligation and the amount at which the settlement will take place can be measured reliably.

What about the value of your brands (goodwill) ?

IAS 1 Presentation of Financial Statements

The Balance Sheet An entity must present a classified balance sheet,

separating the following, unless it is based on liquidity which is deemed more reliable and more relevant, e.g. Financial Institutions:Current assets Non-Current assets Current liabilities Non-Current liabilities

Balance Sheet of F Clothes UK as at 31st December 20xx. Non Current AssetsLand & Buildings 100,000 Capital

500,000Fixtures 20,000 + Net Profit 3,000

120,000 503,000Non Current LiabilitiesBank Loan 30,000

Current Assets Current LiabilitiesInventory 10,000 Accounts Payable

75,000Accounts Rec 120,000Bank 358,000

488,000 608,000 608,000

How would a Financial Institution differ ?

Current assets cash; cash equivalent; assets held for collection, sale, or consumption within

the enterprise's normal operating cycle; or assets held for trading within the next 12 months.

 Non- Current assets All other assets are non-current

Current liabilities Are those to be settled within the enterprise's normal

operating cycle or due within 12 months, or those held for trading, or those for which the entity does not have an unconditional right to defer payment beyond 12 months.

Non- Current liabilities Other liabilities are non-current.

Minimum Balance Sheet Items

a. property, plant and equipment; b. investment property; c. intangible assets; d. financial assets (excluding amounts shown under (e), (h) and (i)); e. investments accounted for using the equity method; f. biological assets; g. inventories; h. trade and other receivables; i. cash and cash equivalents; j. trade and other payables; k. provisions; l. financial liabilities (excluding amounts shown under (j) and (k)); m. liabilities and assets for current tax, as defined in IAS 12; n. deferred tax liabilities and deferred tax assets, as defined in IAS 12; o. minority interest, presented within equity; and p. issued capital and reserves attributable to equity holders of the

parent.   Additional line items may be needed to fairly present the entity's financial

position.

Issued Share Capital and Reserves

The following disclosures are required: numbers of shares authorised, issued and fully paid, and

issued but not fully paid par value reconciliation of shares outstanding at the beginning

and the end of the period description of rights, preferences, and restrictions treasury shares, including shares held by subsidiaries

and associates shares reserved for issuance under options and

contracts a description of the nature and purpose of each reserve

within owners' equity

Balance Sheet Format IAS 1 does NOT prescribe the format of the balance

sheet. Assets can be presented current then non-current,

or vice versa. Liabilities and equity can be presented current

then non-current then equity, or vice versa. A net asset presentation (assets minus liabilities) is

allowed. The long-term financing approach used in UK and

elsewhere – fixed assets + current assets - short term payables = long-term debt plus equity – is also acceptable.

Alternative Presentations

Non Current Assets 100 Equity 150Current Assets 80 Non Current Liabilities 20

Current Liabilities 10

180 180

Non Current Assets 100Current Assets 80Less Current Liabilities 10Net Current Assets 70

170Less Non Current Liabilities 20Net Assets 150

Equity 150

Example

Let’s examine Exhibit 2.2

What does it show ?

Company Value Let us examine two other companies

BP (an Oil Company) & Tesco (a Supermarket)

Have a look at their Balance Sheet’s, BP as at 31st December 2010 & Tesco as at 26th February 2011.

What is the value of each company ?

BP Group Balance Sheet Extract

31st December 2010 $M 2009 $M

Net assets 95,891 102,113

Equity Share capital 5,183 5,179 Reserves 89,804 96,434 BP shareholders’ equity 94,987

101,613 Minority interest 904 500 Total equity 95,891

102,113

Tesco Plc Balance Sheet Extract

26th February 2011 2011 £M 2009 £MNet assets 16,623 14,681EquityShare capital 402 399Share premium account 4,896 4,801Other reserves 40 40Retained earnings 11,197 9,356Equity attributable to owners 16,535 14,596Non-controlling interests 88 85Total Equity 16,623 14,681

Market Value

On 26th February the Market Value of Tesco Plc (Market Capitalisation) was £32.20 bn

The Book Value as shown above as at that date was only £ 16.62 bn

Why the difference ?

Book Value The Book Value as measured by the Balance Sheet is the Net

Assets:Total Assets (Non Current + Current)lessTotal Liabilities (Non Current + Current)

But Tesco, like most businesses is worth more than that. If you were the owner you would own the Net Assets and all

the Future Earnings (or losses). Clearly these are not part of the Book Value.

Whether the future earnings are accurately captured by the market is another matter !

Can you think of any other reason why Book Value and Market Value may be different ?

Net Current Assets

Before leaving Tesco and the Balance Sheet, what do we mean by Net Current Assets ?

Current Assets less Current Liabilities

In Tesco’s case it was:Current Assets less Current Liabilities£11,869 M less £ 17,731 M = (£5,862M)

This is also known as Working CapitalDo you feel it is adequate ?

Summary

The Balance Sheet brings the Finance & Investment Decisions together to present a Statement of the Financial Position as at a certain date.

The Book Value as measured by the Balance Sheet is the Net Assets:

Total Assets (Non Current + Current)lessTotal Liabilities (Non Current + Current)

The Market Value may well differ from the Book Value as, amongst other things, the market seeks to capture the value of Future Earnings