Assessing a Company's Balance Sheet

A company's balance sheet is an integral resource when evaluating whether or not you should invest in a company. It is one part of a company's financial reports. You don't need to know all the technicalities within it, but understanding it will help understand the structure of the company. A balance sheet is an insight into a company's assets, liabilities and what is known as the owner's equity. Assets are anything valuable that a company possesses, liabilities are forms of debt a company may have and owner's equity is the net worth of the company. The net worth is effectively the value of the money first pumped into the business as initial investment plus retained earnings. These three parts balance out (and can be rearranged) as:

Assets = Liabilities + Owner's equity
 
Example: CSR's (LSE:CSR) Balance Sheet 2012

 
The first part of the balance sheet outlines CSR's assets. In this case they are presented in US Dollars. The assets are split into two sections: current and non-current. Current assets can be transferred into cash within 1-year if need be. CSR is a technology hardware company therefore the inventory is unsold stock or raw/semi-finished materials. The inventory levels will vary between different companies as some firms do not hold stock. The cash and cash equivalents are as per the name, hard cash in banks or to hand. Within the current assets, the only other universal point are the 'Trade and other receivables'. This is money owed to the company by third-parties. This is often offset by 'Trade and other payables' which is money owed by the company to third-parties. When a company is larger, they will likely have larger values for both of these.
 
Non-current assets are assets that cannot be transferred into cash as easily. These include capital such as machinery that is listed under 'Property, plant and equipment'. Depreciation (i.e. how a machine becomes less valuable over time) is factored into these values. Non-current assets may also be 'intangible' which literally means unable to be touched. These may include patents.
 
 
Liabilities are also split into current and non-current sections and the categorisations behind these terms are the same. In CSR's case, the trade payables amount to $227m. A useful calculation to do (particularly for smaller companies) is to subtract the payables from the receivables (found in the assets). For CSR this total amounts to -$110m which indicates a trade deficit. Considering that CSR's market cap is currently well over £850m, this deficit is not a cause for concern. However, if the company's market cap was £150m, then it would likely be. That is something to look out for.
 
 
It is not worth worrying about the parts of a company that make up the Equity section. However, note that Total Assets = 1,000,699,000 and Total Liabilities = 305,765,000. The Net Assets or Total Equity amounts to the Assets minus the Liabilities as shown in the initial equation (rearranged).
 
Using this Knowledge
 
Using the knowledge from above, we can start to apply financial ratios to try to understand the company. One of these ratios is known as the 'Debt/Equity Ratio'. This is:
 
Debt/Equity Ratio = Total Liabilities [divided by] Total Equity
 
If the ratio is relatively high it indicates that the company has used debt quite a lot to fund its growth. I stress relatively because you should relate the ratio result to other firms in the industry. The ratio varies between industries. In general though, a figure below 1 is good as it means the company does not have a lot of debt to service relative to equity. Another ratio is known as the Current Ratio:
 
Current Ratio = Current Assets [divided by] Current Liabilities
 
Looking back at CSR, their Current Ratio is 2.1 which is good. A current ratio should ideally be higher than around 1.5 as it indicates that the company should be able to continue paying off its debts, but that is not a hard rule. If the ratio is too low (below 1), it implies the company may struggle to pay of its debts (liabilities) and thus go in search of raising funds through methods such as equity dilutions. A further calculation is for the Net Asset Value (NAV) of a company:
 
Net Asset Value per Share = (Total Assets - Total Liabilities) [divided by] Shares in Issue
 
For CSR this amounts to 694,934,000 in US Dollars. Converting this to GBP gives a current value of around 452,530,000. Dividing that figure by the number of shares in issue (165,670,000) gives a Net Asset Value of 273p/share vs a current share price of 524.50p/share. Therefore it can be concluded that the market is optimistic about the future of the company and is pricing in future earnings growth hence why the disparity is so large. *Also note that the Final Results for CSR are 6 months out of date.* If the disparity is small, or the NAV is above the current share price, it could indicate the company is undervalued. Working Capital can also be calculated:
 
Working Capital = Current Assets - Current Liabilities
 
The Working Capital of a company helps determine whether or not a company can continue paying its bills, paying its salaries and a variety of other costs that are considered fixed. The greater the Working Capital, the more likely it is the company can meet those costs and thus it is in better financial stead.

Here are a few other questions you should ask yourself:
1. Has there been a significant increase in liabilities year-on-year?
2. Has there been a significant decrease in assets year-on-year?
3. What has the change in equity been year-on-year? Has shareholder's money been lost?
If so, try and find out why as it could be a bad omen for the company moving forward.
 
Remember through that the Balance Sheet is a static report for a company at a particular point in time. A company's financials can change during the year (hence why Half-Year Reports are released) so be wary. These methods can help you analyse stocks and compare certain parts of them in a relatively easy and quick way.