A promise is a promise….! So here is the first installment in how to read financial statements….

Let us start at the very beginning….when a company files its Annual Accounts it files the balance sheet, Profit and Loss account, auditors report, directors report…ARE THESE TRUSTWORTHY?

Well they are as trustworthy as your OWN CV.

When I am interviewing a person all I have to do is to realize that HE /SHE is made the cv and to that extent it WILL be biased. A software company may not talk about attrition, but if the market leader TCS talks about attrition, you can rest assured that it is applicable to the whole sector. So it is necessary to see what the LEADER in every industry has to say…and compare it with the other players.

Balance Sheets

A balance sheet gives you the complete detailed information about a company’s assets, liabilities and shareholders’ equity. Shareholder’s equity means the money that belongs to the shareholder – the initial contribution, the money retained (reserves) and the share premium received by the company.

Assets are things that a company owns, has a commercial value and yield some revenue to the company. This typically means they can either be sold (as it is) or used by the company to make products or provide services that can be sold. Normally when we say assets we mean tangible assets – and thus include physical property, such as plants, trucks, equipment, office buildings, furniture, vehicles,  and inventory. It also includes things that can’t be touched but nevertheless exist and have value, such as goodwill, trademarks and patents. Of course the investments that a company makes, the cash that it has on hand and the money that it has to receive from debtors are all assets.

Liabilities are amounts of money that a company has to pay others. This  includes all kinds of obligations, like money borrowed from a bank, rent due but not paid for use of a building, money owed to suppliers for materials, salaries due to its employees, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future – called advances from customers.

Shareholders’ equity is sometimes called capital or net worth. It is the money that would be left if a company sold all of its assets and paid off all of its liabilities. This leftover money belongs to the shareholders, or the owners, of the company. Hence it is that amount of money that belongs to the shareholders if the business was to be wound up today…or on the date of the balance sheet.
Therefore,

ASSETS = LIABILITIES + SHAREHOLDERS’ EQUITY

A company’s balance sheet is set up like the basic accounting equation shown above. On the right side of the balance sheet, companies list their assets. On the left side, they list their liabilities and shareholders’ equity. Sometimes balance sheets show assets at the top, followed by liabilities, with shareholders’ equity at the bottom.

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Assets are generally listed based on how quickly they will be converted into cash. Current assets are things a company expects to convert to cash within one year. A good example is inventory. Most companies expect to sell their inventory for cash within one year. Noncurrent assets are things a company does not expect to convert to cash within one year or that would take longer than one year to sell. Noncurrent assets include fixed assets. Fixed assets are those assets used to operate the business but that are not available for sale, such as trucks, office furniture and other property.

Liabilities are generally listed based on their due dates. Liabilities are said to be either current or long-term. Current liabilities are obligations a company expects to pay off within the year. Long-term liabilities are obligations due more than one year away.

Shareholders’ equity is the amount owners invested in the company’s stock plus or minus the company’s earnings or losses since inception. Sometimes companies distribute earnings, instead of retaining them. These distributions are called dividends.

A balance sheet shows a snapshot of a company’s assets, liabilities and shareholders’ equity at the end of the reporting period. It does not show the flows into and out of the accounts during the period.