Balance Sheet – An important concept in Fundamental Analysis

Here we will discuss about Balance Sheet & its Analysis. Analyzing a Balance Sheet requires a lot of skills & understanding, it is an integral part of fundamental analysis.

Learn everything about the Balance Sheet here & then analyze its for any company.

Concept of Balance Sheet & its Analysis

One of the statements from the list of financial statements is the Balance Sheet. We already know that the statement of profit and loss serves the purpose of telling about the profitability of the company.

On the other hand, the balance sheet tells us about the company’s assets, liabilities, and Shareholder’s equity.

While reading about the Profit and Loss statement, we learned that it is a standalone statement. This means that every year a new profit and loss statement must be made, which is not linked to the statement of the previous year.

This is because the expenses and revenues keep changing every year, which in turn changes the profits. On the other hand, the balance sheet follows a flow basis model.

This implies that it includes the financial information of the company right from its inception.

Therefore, the profit and loss statement tells us about the company’s profitability. In contrast, the balance sheet tells us about the growth of the company.

Balance Sheet Analysis id very important part of fundamental analysis as it helps to determine the performance of any company.

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Heads included in the Balance Sheet

The Analyze a Balance Sheet of a Company, one must know about the terms & particulars involved in the same.

The two major heads in a balance sheet are:

Asset:

An asset is a resource owned by the company, which adds some economic value to the company. As we are well aware, assets are of two categories, i.e., tangible and intangible.

Tangible assets are the ones that have a physical existence, such as Land, Machinery, etc. On the other hand, intangible assets do not have a physical existence such as goodwill, etc.

In the case of financial statements, the assets are divided into two heads that are current assets and non-current assets. We will learn more about them in the latter half of this article.

Liability:

It is the obligations taken by the company with the aim of generating economic value in the long run. In simple words, liability can also be termed as the loan taken by the company with an obligation to pay it back.

Some of the most commonly found liabilities in a balance sheet are short-term borrowings, long-term borrowings, etc. Just like the assets, liabilities are also divided into two major heads.

The two types are non-current liabilities and current liabilities. We will learn more about them in the latter half of this article.

The typical equation of a balance sheet says that: Assets=Liabilities

This means that the assets owned by the company are always equal to the labilities that it is obligated to pay. This is because whatever the company buys is either through liabilities or Shareholder’s funds.

This implies: Shareholder’s fund= Assets – Liabilities

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Format of Balance Sheet

To understand & to perform Balance Sheet Analysis, one should know about the structure in which a balance sheet is prepared.

Balance Sheet of XYZ Company as at March 31, 2020 in Crores

A typical balance sheet in the case of the company looks like the one mentioned above. We will be looking at the major heads in a company’s balance sheet:

Liabilities Section of the Balance Sheet Analysis

To do a through Balance Sheet Analysis, you should have a detailed understating of every details of Balance Sheet.

As visible in the above balance sheet, there are multiple items under the head liabilities. Let us now look at each one of them in detail:

Shareholder’s Fund:

As we discussed above, there are two main sides of a balance sheet i.e., Assets and Liabilities.

Some of you might be confused about how Shareholder’s fund is a part of the liabilities as it represents the Shareholder’s wealth.

As per the Companies Act 2013, it is stated that the company is an artificial person that is separate from its owners. Therefore, the shareholders of the company are separate from the company.

Thinking from this perspective, we realize that the Shareholder’s fund does not belong to the company as it is owned by the shareholders.

Therefore, from the company’s perspective, it is liable to pay back the money to the shareholders. Thus, it is a part of the liabilities.

Format of Shareholder’s Fund

Under the shareholders’ fund, there are two major items, i.e., Share Capital and Reserves & Surplus.

Share Capital

It is the total Capital earned by the company through the issue of shares. To make it simpler, let’s take an example.

Imagine a company Z issuing shares for the first time. The face value of a share is 10 rupees, and the company issues 1000 shares.

In this case, the amount of 10,000 rupees earned by the company is the share capital of the company.

In our company XYZ, the total share capital is 17.081 crores. Supposing, the face value of one share is Rs.10. The total number of shares issued by the company is:

Number of shares = Total share capital / Face value of 1 share = 17081000 crore shares

Reserves and Surplus

Reserves are the portion of profits set aside for specific purposes. On the other hand, the surplus is the profit earned by the company.

In the case of XYZ, the reserves and surplus for the year ended March 31, 2020, is 1345.62 crore rupees.

Some of the most common types of reserves are:

Capital Reserves: Capital reserve is the amount earmarked by the company for long term projects or other expenses that are anticipated by the company.

Securities Premium Reserve: The premium received over the face value on the issue of shares is transferred to the SPR account.

Let the face value of a share be ten, and it is issued at 12. In this case, the extra amount of 2 rupees is the premium, which will be transferred to the SPR account while the remaining goes in Share capital.

General Reserve: The accumulated profits of the company that has not yet been distributed to the shareholders are transferred to General Reserve.

There is no restriction on the usage of the General reserve, and the company can even use it as a buffer.

Non-Current Liabilities:

The long-term obligations are known as non-current liabilities. In the case of companies, the long term means a period of more than 12 months.

Therefore, the obligations that the company intends to pay-off after 12 months from the date of the balance sheet will come under non-current liabilities.

The non-current liabilities in the case of XYZ are:

Long-term Borrowings

It is one of the most crucial items on the liabilities side of the balance sheet.

This is because the long-term borrowings or debt represent the amount owed by the company to various sources.

Apart from this, the long-term borrowings are used as an element while calculating various ratios. The presence of debt shows the amount that the company has borrowed, but its absence is not always a good sign either.

It is important to analyze the reason for no debt. A company that does not plan to expand or a company that is not able to raise debt through lenders might also have zero debt in its balance sheet.

But this is not a healthy indicator.

From Profit and loss statement, we learned about finance costs. The finance cost is directly associated with long term borrowings.

Therefore, higher debt will increase the finance cost and vice versa. In the case of XYZ, the long-term borrowings for the year ended March 31, 2020, are 75.947 crores.

Deferred Tax Liabilities:

The amount of tax paid by the company is never the same for every year. Therefore, a company might foresee that it will have to pay a higher tax in the coming years.

In this case, the company sets aside a certain part of the profits as deferred tax liability for future obligations.

The changes in the amount of tax can be due to the changes in income tax provision or the method of depreciation.

If the company charges higher depreciation, the expenses increase; thus, the tax payable reduces. In the case of XYZ, the deferred tax liabilities for the year ended March 31, 2020, are 30.133 crores

Long term Provisions

The money which is set aside for employee benefits is usually a part of long-term provisions. This might include items like gratuity, leave encashment, provident fund, etc.

In the case of XYZ, the long-term provisions for the year ended March 31, 2020, are 36.957 crores

Current Liabilities:

The short-term obligations are known as current liabilities. In the case of companies, the short term means a period of fewer than 12 months.

Therefore, the obligations that the company intends to pay-off within 12 months from the date of the balance sheet will come under non-current liabilities.

For example: If you buy an electronic device on EMI, you will pay monthly installments for a year. But if you buy real estate, you might take a loan for ten years or so.

In this case, the electronic device creates a current liability while the real estate creates non-current liability.

The current liabilities in the case of XYZ are:

Short-term Borrowings:

As the name suggests, the short-term borrowings are the obligations raised by the company for meeting the working capital requirements.

Some items under short-term borrowings could be bank loans etc. In the case of XYZ, the short-term borrowings for the year ended March 31, 2020, are 8.383 crores.

Trade Payable

The trade payable, also known as account payable, is the amount owed by the company to its vendors. Since the company has diverse products to offer, there can be multiple vendors.

They could be the suppliers of raw material, stationery companies, etc. In the case of XYZ, the trade payable for the year ended March 31, 2020, is 127.779 crores.

Other current liabilities

It includes the obligations of the company that are not directly linked with its operations. It may include items like unclaimed dividends, employee-related payables, etc.

In the case of XYZ, the other current liabilities for the year ended March 31, 2020, are 215.668 crores.

Short-term Provisions

Just like long-term provisions, the short-term provision is the funds set aside for employee benefits, etc. However, the basic difference in the duration of 12 months remains the same.

In the case of XYZ, the short-term provision for the year ended March 31, 2020, is 281.873 crores

Total Liability = Shareholders’ Funds + Non -Current Liabilities + Current Liabilities = 1362.7 + 143.03 +  633.7

Total Liability = Rs.2139.4 Crs

We tried to list the major items found under various heads in the liabilities side of the balance sheet. However, it is recommended to look at the note number mentioned adjacent to each item.

Doing this will help the users of the balance sheet to gain in-depth knowledge about that item.

Assets Section of the Balance Sheet Analysis

The liabilities side of the balance sheet told us about the company’s obligations and the Shareholder’s funds.

The asset side of the balance sheet tells us about the resources owned by the company right from its inception, and the ones added during the business.

These assets help in generating revenue for the company because of which they are termed as resources.

The assets are broadly categorized as two types, i.e.:

Non-Current Assets:

As we read earlier, the term non-current is associated with anything that has a duration of more than 365 days from the date of the balance sheet.

Therefore, non-current assets are the ones that continue to provide economic benefit to the company for a period of more than 365 days.

Any asset owned by the company is expected to work throughout its useful life. The three non-current assets in the above extract are:

Fixed Asset

These are the assets which the company owns, not with the intention of converting them into cash. Fixed assets include both tangible and intangible assets like plant & machinery, land, etc.

Intangible assets also tend to provide economic benefits over a longer period. In the case of XYZ, we have four items under fixed assets, which makes a total of 767.864.

 They are:

• Tangible assets: In the case of XYZ, the tangible assets for the year ended March 31, 2020,are worth 619.894 crores.
• Intangible assets: In the case of XYZ, the intangible assets for the year ended March 31, 2020,are worth 3.296 crores.
• Capital work-in-progress: In the case of XYZ, the Capital work-in-progress for the year ended March 31, 2020,is 144.360 crores
• Intangibles under development: In the case of XYZ, the intangibles under development for the year ended March 31, 2020, are worth 0.314 crores.
• Non-current investments: The investments made by the company for holding them for more than 12 months will come under non-current investments. In the case of XYZ, the non-current investments for the year ended March 31, 2020, are worth 16.076 crores.
• Long-term loans and advances: This includes the amount given by the company to other companies or a group etc. Since the company is obliged to receive money, it comes under assets. In the case of XYZ, the long-term loans and advance for the year ended March 31, 2020, are 56.769 crores.
• Other non-current assets: The other miscellaneous assets held by the company fall under other non-current assets. In the case of XYZ, the non-current assets for the year ended March 31, 2020, are 0.122 crores.

Current Assets:

The assets which are highly liquid in nature and can be easily converted into cash comes under current assets.

The company speculates that these assets will be consumed within a year because of which they fall under current assets.

The current assets mentioned in the balance sheet of XYZ are:

Inventory

Inventory includes finished goods, raw material, and work in progress. These goods are held by the company and not yet sold; therefore, they form a part of current assets.

In the case of XYZ, the inventory for the year ended March 31, 2020, is 335.008 crores.

Trade Receivables

This is the opposite of trade payables. It includes the amount that the company is expected to receive from different sources.

The sources usually include customers, distributors, and other parties. In the case of XYZ, the trade receivables for the year ending March 31, 2020 are 452.789.

Cash and Cash Equivalents:

Cash and cash equivalents are considered to be the most liquid asset. The cash in hand and the amount at the bank forms the cash part.

At the same time, the investments which are highly liquid and can be converted into cash within three months form cash equivalents.

In the case of XYZ, the value of cash and cash equivalents for the year ending March 31, 2020, is 294.5 crores.

Short-term Loans and Advances

The amount lend by the company which is expected to be received withing a year comes under this category.

It might include the amount of receivable from suppliers, loans to customers, etc. In the case of XYZ, the amount of short-term borrowings for the year ending March 31, 2020, is 211.930 crores.

Other current assets

The miscellaneous assets held by the company for a short period comes under other current assets.

In the case of XYZ, the value of other current assets for the year ending March 31, 2020, is 4.316 crores.

Total Assets = Non-current Assets + Current Assets

= 840.831 + 1298.610

= 2139.441 crores

Looking at the first equation, we read, i.e., Liabilities=Assets. We realize that the Equity and Liabilities side of the balance sheet is equal to the asset side.

Conclusion of Balance Sheet Analysis

• The balance sheet is prepared on a flow basis. Therefore, it represents the growth of the company since its incorporation
• Liability is the obligation of the company. At the same time, assets are the resources held by the company.
• Equation 1: Assets = Liabilities
• Liability = Shareholder’s fund + Non-current liabilities + Current Liabilities
• Assets = Current Assets + Non-current assets
• Reserves are a part of the profit set aside to meet the obligations which are anticipated by the company in future
• Equation 2: Shareholder’s fund= Share capital + Reserves + Surplus
• Share Capital = Number of shares*Face value
• Non-current refers to the assets or liabilities that exist for a period of more than 12 months from the date of the balance sheet.
• Current refers to the assets or liabilities that the company consumer or pays back, respectively, within a period of 12 months from the date of the balance sheet.

Note: The balance sheet and statement of profit and loss are directly linked with each other. Let us try to understand this with a few examples:

The company purchases raw material: This transaction affects both the balance sheet and the profit & loss statement.

The purchases of raw material will be reflected in the expenses side of the profit and loss statement. At the same time, the cash balance will reduce.

If the purchase was on credit, it would increase the trade payables.

Finance Cost and Debt: As discussed earlier, both the items are linked. If a company raises debt in the form of bank loans, etc., the finance cost will go up.

This will happen because the company will have to pay higher interest as the value of debt increases. This leads to an increase in finance costs.

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