SFP Analysis: Quick Reference

Statement of Financial Position (SFP) Basics

  • SFP = Balance Sheet; shows assets, liabilities, and owner’s equity as of a specific date.
  • Core equation: \text{Total Assets} = \text{Total Liabilities} + \text{Owner's Equity}
  • Purpose: assess liquidity, solvency, and financial structure at a glance.

Key Analysis Techniques

  • Horizontal Analysis
    • Compare SFPs across years to identify growth or shrinkage in assets, liabilities, and equity.
  • Vertical Analysis
    • Express each line item as a percentage of a key total on the same statement (e.g., total assets).
    • Formula: \text{Vertical \%} = \left( \frac{\text{Account Value}}{\text{Key Total}} \right) \times 100
    • Example: Cash share when Key Total is total assets.
  • Ratio Analysis (Health Check-up)
    • Focus on liquidity, efficiency, and profitability via ratios like the Current Ratio.

Current Ratio: Definition and Interpretation

  • Definition: A liquidity ratio measuring a company’s ability to pay short-term obligations within 1 year.

  • Formula: \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}

  • Snapshot: A single point-in-time metric; not a full performance measure.

  • Interpretation: >1 indicates capacity to cover short-term obligations; <1 suggests liquidity risk.

  • Threshold note: Higher isn’t always better; context matters (industry, working capital needs).

  • Example 1 (Soaper Cleaners Inc., as of 2024-12-31):

    • Current Assets: 50{,}000
    • Current Liabilities: 30{,}000
    • Current Ratio: \frac{50{,}000}{30{,}000} = 1.67

  • Example 2 (XYZ-type):

    • Current Assets: 45{,}000
    • Current Liabilities: 30{,}000
    • Current Ratio: \frac{45{,}000}{30{,}000} = 1.5

How to Read an SFP (Guide Questions)

  • 1) Can the company pay its immediate debts with quick-turn assets? Is the Current Ratio > 1? What does the asset mix imply about liquidity?
  • 2) Do you own more Current Assets or Non-Current Assets? What does this say about short-term liquidity vs. long-term investments?
  • 3) How is the company funded? Is there more in Liabilities or Owner’s Equity? How leveraged is the business?
  • 4) If you were a bank, would you lend more? What additional information would you want (cash flows, income statements, trends, collateral)?

Formulas and Examples

  • Vertical Analysis formula: \text{Vertical \%} = \left(\frac{\text{Account Value}}{\text{Key Total}}\right) \times 100
  • Example: Cash share
    • Cash: \left(\frac{10{,}000}{50{,}000}\right) \times 100 = 20\%
  • Current Ratio (reiterated): \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}

Practical Takeaways

  • Current Ratio > 1 generally indicates the ability to cover short-term obligations; larger gaps suggest stronger liquidity.
  • Horizontal analysis reveals trends in financial health over time.
  • Vertical analysis shows the composition of assets and liabilities, aiding cross-company comparisons.

Quick Reference: Sample SFP Snapshot (Soaper Cleaners Inc.)

  • As of 2024-12-31:
    • Current Assets: 50{,}000
    • Non-Current Assets: 150{,}000
    • Current Liabilities: 30{,}000
    • Non-Current Liabilities: 70{,}000
    • Owner's Equity: 100{,}000
    • Total Assets: 200{,}000
    • Total Liabilities & Equity: 200{,}000
    • Current Ratio: \frac{50{,}000}{30{,}000} = 1.67

Note on Limitations

  • Current Ratio is a snapshot; two companies with the same ratio can have different liquidity profiles and cash conversion speeds. Consider additional data (cash flows, timing of asset realizations) for a fuller picture.