How to read and analyze a balance sheet?
This balance sheet tutorial is a follow-up video to the 2017 Alphabet Inc financial statement
analysis series, and compares the September 30, 2018, balance sheet of Alphabet Inc (the
parent company of Google) to the balance sheet of Facebook on the same date.
As always on the Finance Storyteller channel, this video is for educational purposes only,
none of the comments in this video should be interpreted as investment advice, and I
do not hold any positions in either Alphabet Inc or Facebook stock.
As the video is for educational purposes, please do try this at home (either for other
companies, or the same companies in future quarters), and comment on your findings below!
The balance sheet is an overview of what a company owns and what a company owes at a
specific point in time.
What a company owns is called Assets, what a company owes is called Liabilities and Equity.
The difference between current and non-current assets is whether this asset will be converted
to cash within one year.
The difference between current and non-current liabilities is whether the amounts are due
within one year, or further out.
Let’s put the Alphabet Inc (Google) balance sheet on the left, and the Facebook balance
sheet on the right.
The latest balance sheets available at the time of making this video are those of September
30, 2018.
The balance sheet total for Alphabet Inc on the left is $221.5 billion, for Facebook on
the right $92.5 billion.
So from the balance sheet perspective, Alphabet Inc is a much bigger company.
Alphabet Inc (Google) was incorporated in 1998, Facebook in 2004, in terms of number
of years of existence Alphabet Inc is a few years ahead of Facebook.
Let’s walk through each of the categories on the balance sheet,
starting on the top left: Current Assets.
Current assets are cash and other assets that are expected
to be converted to cash within a year.
Both companies have a huge amount of Current Assets.
For Alphabet Inc, 59% of the total assets.
For Facebook, 53% of the total assets.
This is not unusual for the tech sector, but compared to the Dow Jones Industrial 30 companies
or the S&P 500 this is very high.
Let’s look inside, and see what makes up the Current Assets balance.
For Alphabet Inc, Cash and cash equivalents of 13.4, Marketable securities 93, Accounts
receivable 17.9 (which is equivalent to 48 days of Days Sales Outstanding if you relate
it to Alphabet Inc’s Q3 revenue), Other current assets 5.4,
to get to Total Current Assets of 129.7.
For Facebook, Cash and cash equivalents 9.6, Marketable securities 31.6, Accounts receivable
6.1 (which is equivalent to 40 days of Days Sales Outstanding if you relate it to Facebook’s
Q3 revenue), Other current assets 1.9, to get to Total Current Assets of 49.1.
What jumps out at us in this overview is the very large balances of cash and cash equivalents,
and marketable securities.
Both companies are very cash-rich.
We will find out why once we get to the bottom right of the balance sheets: Equity (which
is the offset on the other side of the balance sheet).
A useful metric to calculate to evaluate a company’s short term liquidity
is the Current Ratio.
The Current Ratio is simply Current Assets divided by Current Liabilities.
Alphabet Inc’s current ratio is 4.1, Facebook’s current ratio is 8.9.
These are very high numbers, compared to a group of 25 Dow Jones Industrial Average companies
that I recently reviewed, that have a current ratio of 1.4.
In short, the liquidity of both Alphabet Inc and Facebook is very high.
Bottom left of the balance sheet: Non-Current Assets.
What does this category consist of?
Alpabet Inc.
Property and equipment 55.3, Goodwill 17.9, Intangible assets 2.4, Other non-current assets
16.2, Total Non-Current Assets 91.8.
Facebook.
Property and equipment 21.1, Goodwill 18.3, Intangible assets 1.5, Other non-current assets
2.5, Total Non-Current Assets 43.4.
What jumps out here is that both companies have around $18 billion in goodwill, which
is related to acquisitions that were done in the past: goodwill is the excess of the
purchase price paid for an acquired firm, over the fair value of its separately identifiable
net assets.
In absolute terms, this is a similar amount for both companies, but in relative terms
(compared to the balance sheet total), this is a much bigger item for Facebook.
Onward to the top right of the balance sheet: Liabilities.
$51.7 billion in total for Alphabet Inc, $12.1 billion in total for Facebook.
Let’s look at the detail that each company provides.
In Current Liabilities, the line item “Accrued expenses and other current liabilities”
is by far the largest for both companies.
For Non-Current Liabilities, Alphabet Inc does and Facebook doesn’t give any line
item detail.
A quarterly earnings release, such as the ones that I retrieved these balance sheets
from, do not provide a lot more detail behind these numbers.
In the December 31 2017 balance sheet analysis for Alphabet Inc (a related video), based
on its more detailed annual report, I did go into more detail for Alphabet Inc’s accrued
expenses, as well as income taxes payable.
Bottom right of the balance sheet: Equity.
On the balance sheet, the Equity balance is stated at the book value.
The market value of the equity in these companies is far higher than that.
Equity as % of the balance sheet total is extremely high for both companies:
77% for Alphabet Inc, 87% for Facebook.
For other companies, I would usually calculate the debt-to-equity ratio as well when doing
a balance sheet analysis.
Given that Alphabet Inc has long-term debt of $4 billion, and Facebook none at all, debt-to-equity
ratio is not a meaningful metric in this comparison.
What is interesting to analyze, is what makes up the Equity balance.
For Alphabet Inc, Common stock and additional paid-in capital 43.1, Retained earnings 128.4,
Accumulated other comprehensive loss of (1.7), make up Total Equity of 169.8.
For Facebook, Common stock and additional paid-in capital 42.4, Retained earnings 38.8,
Accumulated other comprehensive loss of (0.8), make up Total Equity of 80.4.
An interesting coincidence is that for both companies, the amount of total capital contributed
by the shareholders, represented in the first line Common stock and additional paid-in capital
is a similar amount.
Retained Earnings, that part of a company’s cumulative historical profits that has not
been distributed to shareholders through a dividend, is very high for both companies.
Both companies are very profitable, and are growing profitability in the income statement
quickly versus the prior year.
Alphabet Inc (Google) does have the advantage here that it was incorporated in 1998, versus
Facebook in 2004.
Let’s specifically look into the word “Retained” in the term “Retained Earnings”, and review
the companies’ dividend policy as disclosed in the latest annual reports.
Let me read Alphabet Inc’s dividend policy,
which is substantially the same as that of Facebook.
“We have never declared or paid any cash dividend on our common or capital stock.
We intend to retain any future earnings and do not expect to pay any cash dividends in
the foreseeable future.”
This explains the large Retained Earnings balances in Equity.
Very profitable companies that do not pay dividends, have high Retained Earnings balances.
My summary of this short review of Alphabet Inc’s and Facebook’s Q3 2018 ending balance
sheets: both very financially healthy companies, with high scores on financial ratios such
as Current Ratio and Equity as % of total balance sheet.
Thank you for watching!
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