Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.

Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Women's Weekly: Balance sheet deconstructed - Views on News from Equitymaster
  • E-MAIL
  • A  A  A
  • Sep 17, 2009

    Women's Weekly: Balance sheet deconstructed

    Henry R. Luce, founder Time magazine, once observed, "There are men who can write poetry, and there are men who can read balance sheets. The men who can read balance sheets cannot write."

    For many, the balance sheet is like a jigsaw puzzle - just when you feel that you are close to piecing the jigsaw puzzle together and see the picture it reveals, the puzzle throws up a new challenge. You discover that one piece has been incorrectly placed , you don't know which one is it, you just know that the picture cannot be completed unless you unscramble the puzzle and do it all over again.

    This issue of Women's Weekly outlines the importance of the balance sheet for the investor while breaking down its key components.

    The importance of the balance sheet

    The balance sheet is a statement of the company's assets and liabilities. Simply stated, the balance sheet is a record of what the company owes to others and what the company already has, and what others owe to the company.

    Once you know how to read it, you will then be able to understand whether the company really has enough money to support its ambitious expansion plans or whether it will have to take loans (debt) in order to grow, or if the company has a lot of its money blocked in inventories. For example, if a company deals in readymade garments. The garments are a part of the inventory of the company.

    Assets are a chief component of a balance sheet
    Assets and Liabilities are the key components of a balance sheet. 'Assets' can be termed as resources that a company owns and uses to generate cash flows. In simpler words, assets are the total funds that the company owns.

    Assets can be further divided into fixed assets, current assets and investments.

    'Fixed assets' are assets that help companies reap economic benefits over a period of time. Fixed assets are essential in generating revenues and running the business of the company. A company is not very different from an individual. It faces the same concerns that we do, but on a larger scale. We try to cut down our expenses to save more. Companies do the same thing only it is called as 'cost cutting'. We use our skills and abilities to earn a livelihood, similarly companies use fixed assets, such as land, building, plant and machinery, to generate revenues.

    Next in line are current assets. Compare them with you own lifestyle. We as individuals keep aside some cash, which is an asset for us for meeting our day to day expenses. Also, there could be times when your friend may need some money urgently and you may lend it to her. Because she has to repay it at a later date it becomes an asset for you as it is your right to receive that money.

    Similarly a company has 'current assets' on its books that include cash, inventories, debtors and loans and advances. Every company needs to have sufficient cash on its books which it can draw upon for expanding its business or which acts as a buffer when business environment is weak.

    'Debtors' tell you how much repayment is due from parties to whom a company has sold its products. Further, all the products of a company may not be sold during any year. So it will have some products lying in its warehouse which have a value attached to them and this is reflected as 'inventory' under current assets.

    To easily understand 'investments' compare them with your salary or monthly income. What do you do with your salary? Do you spend the entire amount? Save it entirely or do you invest the whole amount?

    Most of us would divide the salary into two parts - savings and invest some part, while spending the rest on things like grocery, clothes, gifts etc. The companies also follow a similar principle. Any surplus cash that companies have after investing into their business is likely to be invested in mutual funds, government bonds or acquiring stakes in other companies.

    Liabilities are a chief component of a balance sheet

    Liabilities are what the company owes and needs to pay to various people or entities like creditors, bankers, shareholders etc. Liabilities can be further classified as borrowings, shareholders fund, current liabilities, etc.

    Say tomorrow, you have your own company and it is doing well. What would be your next step then? You would want to grow your business further. However, what if you don't have the money to do so? Will you be content with what you have or try to borrow money from friends, family or banks in order to expand your business? Companies too face a similar dilemma and the decisions that they take are reflected in the balance sheet.

    If the company decides to borrow money, the amount that it borrows from banks or other lenders gets reflected as 'borrowings'in the balance sheet.

    Next in line are 'current liabilities'. Current liabilities are payments that are short term in nature and are due within a period of one year. Sundry creditors and provisions constitute a part of current liabilities.

    And lastly we discuss the 'Shareholders' funds'. It is that portion of the balance sheet which purely belongs to the shareholders. It consists of equity (funds raised by issuing shares) and reserves and surplus (the accumulated profits that a company has earned and retained overtime).

    Balance sheet as a key to understand the company

    Just like in a puzzle, it is essential to never lose sight of the bigger picture, so things automatically fall into place. A similar principle applies to the Balance Sheet too.

    Rather than just understanding the various terminologies of the balance sheet, it is important to understand what they are trying to convey- the financial state of the company, its ability or inability to grow, take more loans. To understand whether the company you want to invest in is worth your money or not, you must understand the balance sheet in order to get a grasp of the bigger picture.

    With this article, you have now become familiar with the balance sheet. Through our forthcoming issues, we will help you to not only read the balance sheet but also understand what it means. If there is anything in particular that you would like us to cover, write in to us!



    Equitymaster requests your view! Post a comment on "Women's Weekly: Balance sheet deconstructed". Click here!


    More Views on News

    When to Sell Your Investments (Mutual Fund Corner)

    Oct 1, 2015

    We often hear how important it is to start saving and investing to meet your financial goals, but little is said about selling investments.

    More Views on News

    Most Popular

    Demonetisation Barely Made Any Difference to Tax Collections(Vivek Kaul's Diary)

    Aug 7, 2017

    The data tells us quite a different story from the one the government is trying to project.

    A 'Backdoor' to Multibaggers: It's Like Investing in Asian Paints Ten Years Ago(The 5 Minute Wrapup)

    Aug 10, 2017

    Don't miss these proxy bets on growing companies or in a few years you will be looking back with regret.

    Should You Invest In Bharat-22 ETF? Know Here...(Outside View)

    Aug 8, 2017

    Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...

    Signs of Life in the India VIX(Daily Profit Hunter)

    Aug 12, 2017

    The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.

    7 Financial Gifts For Your Sister This Raksha Bandhan(Outside View)

    Aug 7, 2017

    Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...

    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms