Balance Sheet Analysis

Balance Sheet Analysis Notes

Introduction to Balance Sheet Analysis

  • Definition: The balance sheet is a snapshot of a company's financial position at a specific point in time, detailing what it owns (assets) and what it owes (liabilities).
  • Key Components:
    • Assets: What the company owns (goods, cash, inventories, receivables).
    • Equity and Liabilities: What the company owes to shareholders and creditors.

Structure of the Balance Sheet

  • Double-Entry Principle:
    • Assets = Equity + Liabilities
    • This indicates that every financial transaction affects both sides of the balance sheet.

Types of Assets

1. Fixed Assets (Non-current assets)
  • Intangible Assets: Patents, trademarks, goodwill.
  • Tangible Assets: Land, buildings, equipment.
  • Financial Assets: Long-term investments, loans to other entities.
2. Current Assets
  • Inventories: Raw materials, finished goods.
  • Receivables: Money owed to the company, such as trade receivables.
  • Cash/Equivalents: Liquid assets that the company can readily use.

Depreciation and Amortization

  • Depreciation: Allocates the cost of tangible assets over their useful lives.
  • Amortization: Similar to depreciation, but for intangible assets.
  • Formula: Asset at net value = Asset at book value - (Depreciation + Amortization).
  • Methods of Depreciation:
    • Straight-Line: Uniform allocation of cost.
    • Declining Balance: Accelerated depreciation in early years.
    • Economic Depreciation: Based on actual usage.

Equity and Liabilities

  • Equity Sources:
    • Share Capital and Premium
    • Retained Earnings
    • Net Income
  • Liabilities Sources:
    • Provisions
    • Financial and Bank Debt
    • Trade Payables
Equation Overview
  • Assets - Liabilities = Equity

Book Value vs Market Value of Equity

  • Book Value: The value the company reports in its financial statements.
  • Market Value: The current market capitalization (the price investors are willing to pay).
  • Price-to-Book Ratio (PBR):
    • PBR = Market Value of Equity / Book Value of Equity.
    • Indicates growth opportunities.

Net Debt and Financial Leverage

Definitions
  • Net Debt: Financial & Bank Debt - Cash - Marketable Securities.
  • Financial Leverage: Financial Net Debt / Equity.
Leverage Types
  • Gross Leverage: Based on total financial debt.
  • Book Value Leverage: Based on book value.
  • Market Value Leverage: Based on market value.

Working Capital (WC) and Net Working Capital (NWC)

Definitions
  • Working Capital: Long-term funds - Non-current assets.
  • Net Working Capital (NWC): Current Assets - Current Liabilities.
Importance
  • NWC is essential for funding operations; positive NWC indicates that current assets can meet current liabilities.

Economic Capital and Market Value of Economic Assets

  • Economic Assets: Equity + Net Debt.
  • Market Value: Total market value of the company's equity plus any net financial debt.

Examples and Applications

  • Example of Mr. Durand's business creation:
    • Relevant Assets:
    • Store: €100,000, Commercial Property: €50,000, Inventories: €40,000, Cash: €2,000, Bank: €30,000.
    • Total Assets: €222,000.
    • Equity = Savings Collected + Loans.

Practical Application of Ratios

  • Determining financial ratios such as PBR can help assess whether a company's stock is overvalued or undervalued.
  • Understanding working capital is critical in financial planning and cash flow management.