Fundamentals of Corporate Finance

Fourth Edition

Session 2
Section 2.2
The Balance
Sheet
Learning Objective
• Understand the function of the balance sheet
Types of Financial statements
•
There are four main types of financial statements, which are as follows:
•
Income statement. This report reveals the financial performance of an organization for the entire reporting period. ...
•
Balance sheet. ...
•
Statement of cash flows. ...
•
Statement of changes in equity.
2.2 The Balance Sheet (1 of 11)
• Also called “Statement of Financial Position”
• Lists the firm’s assets and liabilities
• Provides a snapshot of the firm’s financial position at a given point in
time
Global Corporation Balance Sheet for 2015 and 2016 ($ millions) (1 of 2)

Table 2.1 Global Corporation Balance Sheet for 2016 and 2015 ($ millions)

Assets 2016 2015

Current Assets blank blank
Cash 23.2 20.5
Accounts receivable 18.5 13.2
Inventories 15.3 14.3
Total current assets 57.0 48.0
Long-Term Assets blank blank
Net property, plant, and equipment 113.1 80.9
Total long-term assets 113.1 80.9
Total Assets 170.1 128.9
Global Corporation Balance Sheet for 2015 and 2016 ($ millions) (2 of 2)

Table 2.1 [Continued]

Liabilities and Stockholders’ Equity 2016 2015
Current Liabilities blank blank
Accounts payable 29.2 26.5
Notes payable/short-term debt 5.5 3.2
Total current liabilities 34.7 29.7
Long-Term Liabilities blank blank
Long-term debt 113.2 78.0
Total long-term liabilities 113.2 78.0
Total Liabilities 147.9 107.7
Stockholders’ Equity Blank Blank
Common stock and paid-in surplus 8.0 8.0
Retained earnings 14.2 13.2
Total Stockholders’ Equity 22.2 21.2
Total Liabilities and Stockholders’ Equity 170.1 128.9
2.2 The Balance Sheet (2 of 11)
• The Balance Sheet Identity
– The two sides of the balance sheet must balance
The Balance Sheet Identity
Assets = Liabilities + Stockholders’ Equity
2.2 The Balance Sheet (3 of 11)
• Current Assets
– Cash and other marketable securities
 Short-term, low-risk investments
 Easily sold and converted to cash
– Accounts receivable
 Amounts owed to the firm by customers who have
purchased on credit
– Inventories
 Raw materials, work-in-progress and finished goods
– Other current assets
 Catch all category that includes items such as prepaid
expenses
2.2 The Balance Sheet (4 of 11)
• Long-Term Assets
– Assets that produce tangible benefits for more than one year
– Recorded value reduced through a yearly deduction called depreciation
according to a schedule that depends on an asset’s life span
 Depreciation is not an actual cash expense, but a way of recognizing that fixed
assets wear out and become less valuable as they get older
2.2 The Balance Sheet (5 of 11)
• Long-Term Assets
– The book value of an asset is its acquisition cost less its accumulated
depreciation
– Other long-term assets can include such items as property not used in
business operations, start-up costs in connection with a new business,
trademarks and patents, and property held for sale
2.2 The Balance Sheet (6 of 11)
• Liabilities
– Current Liabilities
 Accounts payable
– The amounts owed to suppliers purchases made on credit
 Accrual items
– Items such as salary or taxes that are owed but have not yet been paid, and
deferred or unearned revenue
2.2 The Balance Sheet (7 of 11)
• Liabilities
– Net working capital
 The capital available in the short term to run the business:

Net Working Capital = Current Assets − Current Liabilities

2.2 The Balance Sheet (8 of 11)
• Liabilities
– Long-Term Liabilities
 Long-term debt
– A loan or debt obligation maturing in more than a year
2.2 The Balance Sheet (9 of 11)
• Stockholders’ Equity
– Market Value Versus Book Value
 Book value of equity
– Net worth from an accounting perspective
– Assets – Liabilities = Equity
– True value of assets may be different from book value
 Market capitalization
– Market price per share times number of shares
– Does not depend on historical cost of assets
2.2 The Balance Sheet (10 of 11)
• Market to Book Ratio
– The ratio of a firm’s market capitalization to the book
value of stockholders’ equity:
Market Value of Equity
Market-to-Book Ratio=
Book Value of Equity

– Also called Price-to-Book (P/B) ratio

– Sometimes used to classify firms as value stocks (low
M/B) or growth stocks (high M/B)
Figure 2.1 Market-to-Book Ratios in 2016
This figure presents market-to-book ratios of different firms and groups of firms in 2016.
Firms that might be classified as value stocks (low market-to-book ratios) are in red and
those that might be classified as growth stocks (high market-to-book ratios) are in blue.