What is a balance sheet, and how can I read a balance sheet to learn more about the financial
situation of a company?
What do the various financial terms on the balance sheet mean, and how do I understand
the full picture?
The balance sheet is an overview what a company owns and what a company owes at a point in time.
What is owned is on the left, what is owed is on the right.
The balance sheet is one of three very useful financial statements
that a company puts together and publishes.
The other two financial statements are the income statement, an overview of the profit
or income that the company generates during a period,
and the cash flow statement, an overview of how much cash the company generates,
and where it spends that cash during a period.
The balance sheet is a statement of the financial position at a point in time, so it’s like a picture.
The income statement and cash flow statement both cover the flow during a certain period
(usually a month, a quarter, or a year), so they are like a movie, each with its own focus.
When reading a balance sheet, it is important to start off by looking at the balance sheet
by category.
Current assets and non-current assets on the left.
Current liabilities, non-current liabilities, and equity on the right.
Current assets are cash and other assets that are expected to be converted to cash within a year.
Non-current assets are longer-term investments that cannot be converted into cash quickly.
Current liabilities are amounts due to be paid to creditors within twelve months.
Non-current liabilities are amounts owed that are to be paid after the period of one year.
Equity on the balance sheet is the book value of the shareholder capital.
That’s how the balance sheet works on a conceptual level.
Let’s now look into the balance sheet of a real-world company: retail company Walmart.
Walmart’s fiscal year runs from February through January, so we’ll be reviewing the
year-end balance sheet of January 31st, 2020.
Current assets $61.8 billion, non-current assets $174.7 billion,
adding up to total assets of $236.5 billion.
Current liabilities $77.8 billion, non-current liabilities $77.1 billion, equity $81.6 billion.
And as the word balance sheet suggests, the total amount owned equals the total amount owed.
Per the accounting equation: assets equal liabilities plus equity.
Let’s zoom into the balance sheet in more detail, and review what is in each of the
balance sheet categories: current assets, non-current assets, current liabilities,
non-current liabilities, and equity.
Same five categories, just a lot more detail to dig into.
In the American format of the balance sheet,
assets are listed from most liquid to least liquid.
Liabilities are listed from due first to due last.
I will take you through the main line items.
Cash is the most liquid asset.
$9 billion in cash and cash equivalents might sound like a lot of money in absolute terms,
but relative to the size of Walmart’s operations (with $520 billion in annual net sales), this
balance is actually relatively small.
Receivables is the next most liquid asset, as it is very close to cash.
You might ask yourself: how come Walmart has receivables, don’t we the consumers all
pay cash or by card when we shop?
True! Receivables at Walmart are primarily due from insurance companies resulting from pharmacy
sales; banks for customer credit and debit cards and electronic bank transfers that take
in excess of seven days to process; governments for income taxes; suppliers for marketing
or incentive programs; and real estate transactions.
This kind of information can be found in the notes to the financial statements.
As you would expect, inventories (the goods that Walmart holds to sell) are a very big
amount: $44 billion.
Property and equipment, in non-current assets, is the single largest line item among the
assets on Walmart’s balance sheet: $105 billion.
Land, buildings, fixtures and equipment, transportation equipment, and construction in progress.
Property and equipment is a non-current asset, as it is a long-term investment, with estimated
useful lives of certain asset classes up to 30 or even 40 years.
Operating leases and financial leases are new line items on the balance sheet, since
the recent introduction of the new leasing standard ASC 842.
Whereas leases used to be “off balance sheet”, the new accounting standard require lessees
to recognize right-of-use assets and lease liabilities on their balance sheets.
For Walmart, in terms of the amounts, the lease assets are pretty much offset by the
short-term lease obligations and long-term lease obligations.
Net impact on the balance sheet zero,
but what is owned and what is owed now explicitly spelled out.
The goodwill on Walmart’s balance sheet is primarily related to Walmart International:
the difference between the purchase paid for retail operations that Walmart acquired, and
the fair value of the net assets acquired in the business combination.
Now that we know what the main line items on the assets side of the balance sheet mean,
it is important to put things in perspective by clearly identifying the top three in terms
of size: property and equipment $105 billion, inventories $44 billion, goodwill $31 billion.
That’s more than 75% of the value of the assets in just three lines.
On to the liabilities and equity side of the balance sheet.
Accounts payable, invoices received from suppliers but not paid yet, $47 billion.
Accrued liabilities (per the notes to the financial statements), consists of amongst
others accrued wages and benefits, insurance-related liabilities, accrued taxes such as payroll
and sales tax, and deferred gift card revenue, totaling $22 billion.
Long-term debt due within one year is exactly what it says: that part of the long term debt
that is to be repaid, or renewed, within one year.
Long-term debt of $44 billion is US dollar, Euro, Sterling, or Yen denominated debt with
maturity dates up to 30 years in the future (per the notes to the financial statements).
Within equity (the book value of the shareholder capital), the largest line item in $ size
is retained earnings: the part of the company’s cumulative historical profits that has not
been distributed to shareholders through a dividend.
Another interesting one is noncontrolling interest: most of this ($4.3 billion) is related
to Walmart’s acquisition in August 2018 of a majority stake in Flipkart, an Indian-based
eCommerce marketplace.
The noncontrolling interest is the part of the shareholder capital of Flipkart that Walmart
didn’t buy, but somehow has to account for.
In the acquisition, Walmart assumed the assets as well as the liabilities of Flipkart, and
through the line noncontrolling interest has to represent that it doesn’t own all of
the equity in the subsidiary.
On the liabilities and equity side of the balance sheet, the top three in terms of size
are: equity of $82 billion, accounts payable of $47 billion, and long term debt of $44 billion.
Here’s the next level of understanding of the balance sheet: comparing what you find
on the left and what you find on the right.
In the area of working capital management, Walmart’s inventory balance of $44 billion
is financed by Walmart’s suppliers (through accounts payable of $47 billion).
The balance sheet: an overview of what a company owns and what a company owes at a point in
time, which can tell very interesting stories about the financial situation of a company.
If you have any questions about the balance sheet,
then please post them in the comments below.
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