BM2003

BASIC FINANCIAL STATEMENTS I

Statement of Financial Position
Statement of Financial Position (SFP), also known as a balance sheet or statement of net worth,
presents the financial condition of a company at a point in time. It includes the company's assets, and
how these assets are financed, through either debt or equity.

Statement of Financial Position, like all other financial statements, differs between organizations.
However, there are several line items of the SFP that are common to all. These are as follows (CFI
Education Inc., 2020):

Current Assets
 Cash and Cash Equivalents - Cash is considered as the most liquid of all assets and appears on
the first line of SFP. On the other hand, Cash Equivalents include assets that have short-term
maturities under three (3) months or assets that the company can liquidate on short notice,
such as Marketable Securities.
 Accounts Receivable - This account includes the balance of all sales revenue still on credit, net
any allowances for doubtful accounts.
 Inventory - It includes amounts for raw materials, work-in-process goods, and finished goods.
 Prepaid Expenses - These are expenses paid by the company before they are used or incurred.
Non-Current Assets
 Property, Plant, and Equipment (PPE) - This account captures the company's tangible fixed
assets. This line item is usually net of depreciation. Some companies will class out their PPE by
the different types of assets such as land, building, and equipment. All PPEs are depreciable
except for land.
 Intangible Assets - This line item includes all of the company's intangible fixed assets, which may
or may not be identifiable. Identifiable intangible assets include patents, licenses, and secret
formulas. Unidentifiable intangible assets include brand and goodwill.

Current Liabilities

 Accounts Payable (AP) - This account represents the amount owed by the company to suppliers
for items or services purchased on credit.
 Notes Payable - This includes non-AP obligations that are due within one (1) year (usual
operating period here in the Philippines) or one (1) operating cycle, whichever is longer.
 Current Portion of Long-Term Debt - It is the portion due within the current year of a debt that
has a maturity of more than a year. For example, if a company takes on a bank loan to be paid
off in five (5) years. That account both includes a current portion and a non-current portion.

Non-Current Liabilities

 Bonds Payable - This account includes the amortized amount of any bonds the company has
issued.

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 Long-Term Debt - This account includes the total amount of long-term debt (excluding the
current portion) derived from the debt schedule, which outlines all of the company's
outstanding debt, the interest expense, and the principal repayment for every period.

Shareholders' Equity

 Share Capital - This is the value of funds that shareholders have invested in the company. When
a company is first formed, shareholders will typically put in cash. For example, an investor starts
a company and seeds it with P10M. Cash (an asset) rises by P10M, and Share Capital (an equity
account) increases by P10M, balancing out the SFP.
 Retained Earnings – This is the total amount of net income the company decides to keep. Every
period, a company may pay out dividends from its net income. Any amount remaining (or
exceeding) is added to (deducted from) retained earnings.

Illustrative Example 1 (Weygandt, Kimmel, & Kieso, 2018)

The following accounts were taken from the financial statement of KC Company:

Salaries and wages payable Stock investments, long-term

Service revenue Equipment
Interest payable Accumulated depreciation - equipment
Goodwill Depreciation expense
Debt investments, short-term Owner's capital
Mortgage payable, due in three (3) years Unearned service revenue

Requirement: Match each account to its proper statement of financial position classification, using the
two (2) or three (3) letter abbreviations, as shown below. If the item would NOT appear on SFP, use "NA."
 CA (Current assets)
 LTI (Long-term investments)
 PPE (Property, plant, and equipment)
 IA (Intangible assets)
 CL (Current liabilities)
 LTL (Long-term liabilities)
 OE (Owner's Equity)
Importance of Statement of Financial Position
SFP is important for many reasons. It can be analyzed on its own or in conjunction with the other
statement such as income statement or cash flows, to get a full picture of a company's financial health.
The importance of SFP are as follows (CFI Education Inc., 2020):

 Liquidity - Comparing a company's assets to its current liabilities provides a picture of

liquidity. Current assets should be greater than current liabilities so that the company can cover
its short-term obligations. The current ratio and quick ratio are examples of financial liquidity
metrics.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

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A current ratio below one (1) indicates that the company's liabilities in a year or less are greater
than its current assets. The higher current ratio means the company has higher capability to pay
off its short-term liabilities. However, if the company has a high current ratio, say above four (4),
it may indicate they are not using its current asset efficiently or maximizing its working capital.

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝑄𝑢𝑖𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The quick ratio indicates a company's capacity to pay its current liabilities without needing to
sell its inventory or get additional financing. A result of one (1) is considered to be the normal
quick ratio. It indicates that the company is fully equipped with exactly enough assets to be
instantly liquidated to pay off its current liabilities. A company that has a quick ratio of less than
one (1) may not be able to fully pay off its current liabilities in the short term, while a company
having a quick ratio higher than one (1) can instantly get rid of its current liabilities.

 Leverage - It is the use of debt to finance the company or a specific project. For example, a
company can use leverage to purchase a particular asset. In other words, instead of issuing stock
to raise capital, companies can use debt financing to invest in business operations in an attempt
to increase shareholder value. Comparing debt to equity and debt to total assets are common
ways of assessing leverage on the balance sheet.

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 + 𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡 + 𝑂𝑡ℎ𝑒𝑟 𝑓𝑖𝑥𝑒𝑐𝑑 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠

𝐷𝑒𝑏𝑡 𝑡𝑜 𝑒𝑞𝑢𝑖𝑡y= 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′𝑒𝑞𝑢𝑖𝑡𝑦
The result indicates how much higher
is the liabilities of the company from
its equity in percentage. 𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
𝑜𝑟
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′𝑒𝑞𝑢𝑖𝑡𝑦

The debt to equity ratio of 1.5 indicates that the liabilities of the company are 150% greater than
its equity. This means that the company is getting more of its financing by borrowing money. In
that case, there is a greater risk that they may face bankruptcy in times of crisis.
The result indicates how huge in percentage
𝑇𝑜𝑡𝑎𝑙 𝑑𝑒𝑏𝑡
is financed by creditors, the remaining is 𝐷𝑒𝑏𝑡 𝑡𝑜 𝑎𝑠𝑠𝑒𝑡 =
the percentage financed by the company. 𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

If a company has a debt to asset ratio of .70, it means that 70% of its assets are financed by
creditors, and 30% are financed by owners of the company.
 Efficiency - By using the income statement in connection with the balance sheet, it is possible to
assess how efficient a company uses its assets. For example, dividing revenue into fixed assets
produces the asset turnover ratio, which indicates how efficient the company turns its assets
into revenue.
𝐴𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑟𝑎𝑡𝑖𝑜= 𝑁𝑒𝑡 𝑠𝑎𝑙𝑒𝑠
The higher the turnover ratio, the
more efficient in using assets to 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 Beg. Total Assets + End. Total Assets
generate revenue. 2

The asset turnover ratio helps investors see how effective the company is utilizing its assets. For
example, JEK Company had total revenue of P1,000,000 for 2X20. Its total assets were P300,000

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at the beginning of the 2X20 and P500,000 at the end. Hence, the average total assets is
P400,000 [(P300,000 +P500,000)/2]. The asset turnover ratio is 2.5 (P1,000,000/P400,000).

On the other hand, NES Company, belonging to the same sector as JEK Company, had total
revenue of P8,000,000 at the end of 2X20. Its total assets were P1,000,000 at the beginning of
2X20 and P2,000,000 at the end. Hence, the average total assets is P1,500,000 [(P1,000,000
+P2,000,000)/2]. The asset turnover ratio is 5.33 (P8,000,000/P1,500,000).

Comparing the two (2) assets turnover ratios, NES Company is more efficient in using its assets
to generate revenue than JEK Company.

 Rates of Return - It is the use of SFP to evaluate how well a company generates returns. The
examples of metrics are return on equity, return on assets, and return on invested capital.

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑒𝑞𝑢𝑖𝑡𝑦 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒Sℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′E𝑞𝑢𝑖𝑡𝑦

The return of equity (ROE) ratio provides an investor with a picture of how profitable a particular
sector if compared to the overall market. It can also be used to look at individual companies to
compare their ROEs with the companies within their industry.

For example, Business Process Outsourcing (BPO) industry performs well compared to the
market as a whole during the COVID-19 pandemic, with an ROE value of 27.5%, followed by
general utilities and retail industry which had 12.8% and 19.2%, respectively. This percentage
can indicate that the BPO industry provides an excellent return to investors in the overall
market.

Also, assume that Puregold Price Club, Inc. reported a net income of P128,000,000 and a total
shareholders' equity of P1,000,000,000 for 2X20. Hence, Puregold’s ROE for 2X20 was 12.8%
(P128,000,000/P1,000,000,000). This means that in every peso of shareholders' equity, Puregold
generated 12.8 cents in profit. If Puregold's ROE in 2X19 is 10.8%, it shows that the company
improved its performance in generating profits. However, if compared within its industry (the
retail industry with an average ROE of 19.2%), the company's ROE was below average.

𝑁𝑒𝑡 𝑖𝑛𝑐𝑜𝑚𝑒
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑎𝑠𝑠𝑒𝑡𝑠
= 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Return on assets measures the company's profitability relative to its assets on the statement of
financial position. For example, REG Company operates as a construction company in
Mandaluyong City. In 2020, the company's assets show a beginning balance and ending balance
of P1,000,000 and P2,000,000, respectively. During the year, the company had a net income of
P20,000,000. Based on the given information, the company’s return on assets is 1,333.33%
[P20,000,000/(P1,000,000+P2,000,000)/2]. This means that every peso invested in the asset of
the company earned P13.33 of net income.
References
CFI Education Inc. (2020). What is balance sheet? Retrieved April 2, 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/balance-sheet/
Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting principles 13th Ed. New Jersey: John Wiley & Sons.

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