Lesson 5:

The Balance Sheet

Before I made Pulp Fiction, I considered leaving acting to become an accountant. Some
people think acting skills aren’t transferable to accounting, but I think the CFO of Enron
would have disagreed.
- Samuel L. Jackson
 Today’s Topics
- Current vs. noncurrent assets
Classified Balance Sheet - Current vs. long-term liabilities

- Notes related to balance sheet items

Financial Statement Notes

- Book vs. market value of assets

Book Value vs. Market Value - Book vs. market value of equity

- Usefulness of the balance sheet

Analyzing the Balance Sheet - Limitations of the balance sheet
 Today’s Topics
- Current vs. noncurrent assets
Classified Balance Sheet - Current vs. long-term liabilities

- Notes related to balance sheet items

Financial Statement Notes

- Book vs. market value of assets

Book Value vs. Market Value - Book vs. market value of equity

- Usefulness of the balance sheet

Analyzing the Balance Sheet - Limitations of the balance sheet
 Classified Balance Sheet
• Recall that the balance sheet lists asset,
liability, and stockholders’ equity
accounts
– We can further classify asset and liabilities as:
Current Assets Noncurrent Assets

Current Liabilities Long-term Liabilities

 Current Assets
Current assets include cash and assets the company
expects to convert to cash (or use up) within one year or
the length of the operating cycle, whichever is longer.

The operating cycle is the number of days it takes

to sell inventory and collect cash from customers
 Examples – Current Assets
• Cash and cash equivalents
• Short-term investments
• Accounts receivable
• Inventory
• Prepaid expenses

Current assets are listed

in order of liquidity.
 Noncurrent Assets
Any asset that isn’t a current asset
is a noncurrent asset.

This includes:
• Property, plant, and equipment
• Long-term investments
• Intangible assets
 Current Liabilities
Current liabilities are liabilities that will become due
within one year or the length of the operating cycle,
whichever is longer.
Examples – Current Liabilities
• Accounts payable
• Wages payable
• Accrued expenses
• Unearned revenue
• Current portion of long-
term debt
 Long-term Liabilities
Any liability that isn’t a
current liability is a long-
term liability.

This includes:
• Long-term debt
• Lease liabilities
• Pension liabilities
• Asset retirement obligations
 Classified Balance Sheet
Current Assets

Long-term Investments
ASSETS
Property, Plant, and Equipment
Not all balance sheets
Intangible Assets
are arranged in this
exact manner

Current Liabilities
LIABILITIES
Long-term Liabilities

STOCKHOLDER’S
Stockholders’ Equity
EQUITY
 current A
S
assets
S
E
noncurrent T
assets S

L
I
A
current B
liabilities I
L
I
T
long-term I
liabilities E
S

E
equity Q
U
IT
Y
Quiz A
The information on your right pertains to
The Dancing Squirrel as of 12/31/2019.
Prepare a classified balance sheet as of
12/31/2019.
 Today’s Topics
- Current vs. noncurrent assets
Classified Balance Sheet - Current vs. long-term liabilities

- Notes related to balance sheet items

Financial Statement Notes

- Book vs. market value of assets

Book Value vs. Market Value - Book vs. market value of equity

- Usefulness of the balance sheet

Analyzing the Balance Sheet - Limitations of the balance sheet
 Notes to the Financial Statements
• Note 1 usually provides
information about the
company’s accounting
policies
• Other notes provide
information about:
– Debt (interest rates, maturity
dates)
– Sales/profit by operating
segment
– Property, plant, and equipment Many topics are covered in the
– Other topics notes. Every company is different
On the next few slides, you’ll see excerpts from Home Depot’s notes.
Don’t worry too much about the details, I’m just trying to show you
what kind of information you can expect to find in a company’s notes.
Note 1 –Accounting Policies
Home Depot’s notes show that its accounts receivable
contains several different types of receivables.
Note 1 –Accounting Policies

Home Depot also discloses its method of depreciation

(the straight-line method) and the estimated useful lives
over which it depreciates property and equipment.
Note 1 –Accounting Policies

Home Depot tells you how it accounts for

unredeemed gift cards (breakage income).
Note 1 –Accounting Policies

Home Depot tells you which costs are

included in its cost of goods sold.
Note 1 –Accounting Policies

Home Depot tells you how much of its selling,

general, and administrative (SG&A) expense
consists of ad spend.
 Note 3 – Property

Whereas Note 1 disclosed Home Depot’s depreciation method and

estimated useful lives, Note 3 provides a breakdown of each item
includes in Home Depot’s property, plant, and equipment.
 You can now see the importance of the
notes to the financial statements.

The notes provide additional details about the figures in the financial
statements, plus information about the company’s use of estimates
and its accounting policies.
 Today’s Topics
- Current vs. noncurrent assets
Classified Balance Sheet - Current vs. long-term liabilities

- Notes related to balance sheet items

Financial Statement Notes

- Book vs. market value of assets

Book Value vs. Market Value - Book vs. market value of equity

- Usefulness of the balance sheet

Analyzing the Balance Sheet - Limitations of the balance sheet
 Asset Values
This is the asset section of Walmart’s balance sheet.

Is this the amount Walmart could Is this the amount Walmart

sell its property and equipment for? could sell its inventory for?
 Asset Values
This is the asset section of Walmart’s balance sheet.

Is this the amount Walmart could Is this the amount Walmart

sell its property and equipment for? could sell its inventory for?

No.
Those numbers do not
represent the fair market
values of those assets. They
represent the “book value.”
 For many types of assets:
book value of market value
the asset of the asset
 Let’s look at another example
• Coca-Cola is sugar water, yet it generates billions of dollars in annual sales.
How?
• Some say it’s because Coca-Cola has built a strong brand and has valuable
trademarks.
• But look at the assets on Coca Cola’s balance sheet.
• Coca-Cola’s “brand” doesn’t appear on its balance sheet, and trademarks have
the 4th highest book value among Coca-Cola’s assets.
 Key Takeaways:
Takeaway Why? Examples
Some assets are not These “assets” don’t meet Brand value, expertise of
recorded on the balance the accounting rules for employees, etc.
sheet. recording an asset.
Some assets appear on the These assets are recorded Trademarks, inventory, etc.
balance sheet but are at their cost (purchase
understated relative to price), not their fair market
their fair market value. value.
Because some assets are not recorded or understated,
the book value of the company’s equity will be lower
than the market value of equity.

book value market value

of equity of equity
 This was LinkedIn’s balance sheet
prior to being acquired in 2016.

This explains why Microsoft paid $26

billion to acquire LinkedIn in 2016 even
though LinkedIn’s total stockholders’
equity was only $4 billion.
 Total Stockholders’ Equity
• If you’d like additional proof that the book value
of a company is not the same as the company’s
market value, note that total stockholders’
equity is negative for some companies
– It obviously isn’t possible for a company to
have a negative market value; thus, the book
value and the market value are clearly NOT
the same thing
 Example – Negative Equity
Here’s an excerpt from Here’s an excerpt from
Sears’ balance sheet Gymboree’s balance sheet
as of 2/3/18 as of 1/27/18

Negative equity can occur when a

When total stockholders’ equity is negative,
company piles up a lot of losses or
it is usually called total deficit.
repurchases a lot of its stock.
 Today’s Topics
- Current vs. noncurrent assets
Classified Balance Sheet - Current vs. long-term liabilities

- Notes related to balance sheet items

Financial Statement Notes

- Book vs. market value of assets

Book Value vs. Market Value - Book vs. market value of equity

- Usefulness of the balance sheet

Analyzing the Balance Sheet - Limitations of the balance sheet
 Usefulness of the Balance Sheet
• The balance sheet allows you to:
– Examine a company’s capital structure
To what extent are the assets financed by debt? By equity?

– Assess a company’s short-term liquidity

You can calculate ratios (e.g., current ratio, quick ratio) to see if the
company is in a good position to pay its short-term bills

– Assess a company’s long-term solvency

You can calculate ratios (e.g., debt-to-equity ratio) to see if the
company is so highly leveraged that it might have trouble paying its
debt in the long-run

– Calculate rates of return

In conjunction with profitability metrics from the income statement,
you can calculate the return on assets (ROA) or return on equity (ROE)
 Short-term Liquidity Ratios

Current Assets
Current Ratio =
Current Liabilities

Cash & Cash Equivalents + Short-term Investments + A/R

Quick Ratio =
Current Liabilities
Long-term Solvency Ratios

Total Debt
Debt Ratio =
Total Assets

Total Liabilities
Debt to Equity Ratio =
Total Stockholders’ Equity
 Rates of Return

Net Income
ROA =
Average Total Assets

Net Income
ROE =
Average Total Stockholders’ Equity
 Limitations of the Balance Sheet
Some assets are undervalued Some assets aren’t recorded
• Buildings • Brand value
• Land • Creativity of company’s
• Equipment engineers/staff
• Trademarks • R&D
• Copyrights
• Patents
• Inventory

Remember: the balance sheet does NOT tell

you the fair value of all the company’s assets
or the fair value of the company’s equity