Balance Sheet Tooltips
Assets
Definition: A business asset is an item of value owned by a company. Business assets span many categories. They can be physical, tangible goods, such as vehicles, real estate, computers, office furniture, and other fixtures, or intangible items, such as intellectual property.
Business assets are divided into two sections on the balance sheet:
Current Assets
Current assets are business assets that will be turned into cash within one year.
Examples:
Cash and Bank, Marketable securities, Inventory and receivables, debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
Non-Current Assets
Non-current assets, or long-term assets are less liquid assets that are expected to provide value for more than one year. In other words, the company does not intend on selling or otherwise converting these assets in the current year. Non-current assets are generally referred to as capitalized assets since the cost is capitalized and expensed over the life of the asset in a process called depreciation.
Examples:
Property, Buildings, Equipment, Motor Vehicles, Furniture and Fittings.
Liabilities
Definition: A liability, is an obligation to, or something that you owe somebody else. Liabilities are defined as a company’s legal financial debts or obligations that arise during the course of business operations. They can be limited, or unlimited liability. Liabilities are settled over time through the transfer of economic benefits including money, goods, or services.
Business liabilities are divided into two sections on the balance sheet:
Current Liabilities
Current liabilities are business liabilities that will be settled or paid within one year.
Examples:
Bank Overdrafts, Short term loans, Payables owed by the company to its suppliers for goods or services that have been delivered or used but not yet paid for.
Non-Current Liabilities
Long term liabilities are business debts which are payable, or are to be settled in a period exceeding one year.
Examples:
Long term loans, Shareholders loans, related party loans.
Equity
Definition: Equity is typically referred to as shareholder equity (also known as shareholders’ equity) which represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off.
Calculation of Equity:
Equity = Assets minus Liabilities.
Business equity included in the balance sheet:
Shareholders' Equity
Shareholder equity (SE), also referred to as shareholders’ equity and stockholders’ equity, is a corporation’s owners’ residual claim after debts have been settled.
Retained Earnings
Retained earnings forms part of shareholders equity and can be viewed as a business savings since it represents a cumulative total of profits that have been saved and put aside or retained for future use. Retained earnings should grow larger over time as the company continues to reinvest a portion of its income. Retained earnings are the portion of Net earnings that were not paid to shareholders as dividends.
Liabilities & Equity
Definition:
Liabilities plus Equity represents the balancing figure on the balance sheet. The total value of liabilities plus equity is equal to the value of the total assets of a business.
Calculation:
Assets = Liabilities plus Equity
Current Liabilities
Definition:
Current liabilities are business liabilities that will be settled or paid within one year.
Examples:
Bank Overdrafts, Short term loans, Payables owed by the company to its suppliers for goods or services that have been delivered or used but not yet paid for.
Current Assets
Definition:
Current assets are business assets that will be turned into cash within one year.
Examples:
Cash and Bank, Marketable securities, Inventory and receivables, debts owed to a company by its customers for goods or services that have been delivered or used but not yet paid for.
Fixed Assets
Definition:
A fixed asset is a long-term tangible piece of property or equipment that a business owns and uses in its operations to generate income. Fixed assets are not expected to be consumed or converted into cash within a year.
Examples:
Property, Buildings, Equipment, Motor Vehicles, Furniture and Fittings.
Capital Employed
Purpose
Identifies how a company is investing its money and is more specifically used in the Return on Capital Employed Ratio.
In other words
The value remaining after deducting all a company’s short-term liabilities from the total value of it’s assets.
Method
Fixed Assets plus Current Assets less Current Liabilities.
Note
A negative result means that the business has short term debt which exceeds the value of its assets. This would indicate a high-risk business investment.
Working Capital
Purpose
Represents a company’s ability to pay its current liabilities with its current assets.
In other words
The value remaining after deducting a company’s short-term liabilities from its short-term assets.
Method
Current Assets less Current Liabilities.
Note
A negative result means that the business has short term debt which exceeds the value of its short-term assets. This would indicate a high-risk business investment.
EBITDA
Earnings Before Interest, Tax, Depreciation and Amortization
Definition: EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization), is a measure of a company’s overall financial performance and is used as an alternative to NPAT (Net Profit After Tax) and NPBT (Net Profit Before Tax) in some circumstances.
Calculation of EBITDA:
Net Profit minus (Interest Expense plus Tax plus Depreciation plus Amortization.
Note
EBITDA can be misleading because it strips out the cost of capital investments like property, plant, and equipment.
EBBITDA also excludes expenses associated with debt by adding back interest expense and taxes to earnings.
NPBT
Net Profit Before Tax
Definition: NPBT (Net Profit Before Tax) is a measure that looks at a company’s profits before the company has to pay corporate income tax. It deducts all expenses from revenue except for income tax.
Calculation of NPBT:
Revenue minus all operating and overhead expenses except corporate tax.
Note
NPBT exists because tax expense is constantly changing and taking it out helps give an investor a good idea of changes in a company’s profits or earnings from year to year.
The term NPBT is interchangeable with “earnings before tax” or “pre-tax profit”.
NPAT
Net Profit After Tax
Definition: Net Profit After Tax (NPAT) is the sum of all revenues minus all expenses, including cost of goods sold, depreciation, interest, and taxes.
Calculation of NPAT:
Revenue minus all operating and overhead expenses including corporate tax.
Note
While it is the same as net income, for the most part, it is used in financial statements to differentiate between income before tax and income after tax. Since it is the last line on a company’s income statement, NIAT is also referred to as the bottom line.
Debt Equity Ratio
Purpose
Identifies how much of the business debt is financed by Owner Funds versus Loaned Funds.
In other words
The ability of Shareholder Equity to cover all debt in the event of a business downturn.
Method
Total Owners Equity divided by Total Liabilities (Whether interest bearing or not).
Ideal result
Industry specific with a result between 1 and 1.5 being acceptable. A lower result indicates a lower business risk.
Low risk example and a better investment
Total Liabilities: 50,000
Owners’ Equity: 100,000
Result: Debt Equity Ratio = 0.5
High risk example
Total Liabilities: 100,000
Owners’ Equity: 25,000
Result: Debt Equity Ratio = 4.0
Note
A negative result means that the business has an Accumulated Loss (which exceeds the value of Share Capital), rather than a Retained Income. This would also indicate a high-risk business investment.
Quick Ratio
Purpose
A Liquidity Ratio, which measures a company’s ability to meet its short-term obligations with its most liquid assets.
In other words
The number of times a company can pay its short-term debt with its most liquid assets. Inventory is specifically excluded from this ratio as it is often difficult to sell in the short-term. Rushing the sale of inventory may result in selling some or all inventory at a loss.
Method
(Current Assets minus Inventory) divided by Current Liabilities.
Ideal result
Industry specific with a result between 1 and 2 being acceptable. A lower result indicates a higher business liquidity risk.
Low risk example and a better investment
Current Assets minus Inventory: 500,000
Current Liabilities: 300,000
Result: Quick Ratio = 1.67
(This business is able to cover its Current Liabilities 1.67 times out of its most liquid assets).
High risk example
Current Assets minus Inventory: 600,000
Current Liabilities: 700,000
Result: Quick Ratio = 0.86
(This business is unable to cover its Current Liabilities out of its most liquid assets as the result is less than one).
Note
A result lower than 1 means that the Current Liabilities exceed (Current Assets minus inventory). This indicates a higher liquidity risk.
Current Ratio
Purpose
A Liquidity Ratio, which measures a company’s ability to meet its short-term obligations with its Current Assets.
In other words
The number of times a company can pay its short-term debt with its Current Assets. Similar to the Quick Ratio, with the difference being that inventory remains included in the Current Asset Value.
Method
Current Assets divided by Current Liabilities.
Ideal result
Industry specific with a result between 1 and 3 being acceptable. A lower result indicates a higher business liquidity risk.
Low risk example and a better investment
Total Liabilities: 900,000
Owners’ Equity: 300,000
Result: Current Ratio = 3.00
(This business is able to cover its Current Liabilities 3 times out of its Current Assets).
High risk example
Current Assets: 400,000
Current Liabilities: 500,000
Result: Current Ratio = 0.80
(This business is unable to cover its Current Liabilities out of its Current Assets as the result is less than one).
Note
A result lower than 1 means that the Current Liabilities exceed Current Assets. This indicates a higher liquidity risk.
Return on Capital Employed (ROCE) Ratio
Purpose
A Profitability Ratio, which measures a company’s profitability and the efficiency with which its capital is used.
In other words
How well a company is generating profits from its capital. To justify Investing funds into a business instead of keeping the funds in a fixed percentage investment, the investor must expect a return that is significantly higher than the fixed investment would yield.
Method
Earnings before interest and tax (EBIT) divided by Capital Employed. Capital Employed = (Fixed Assets plus Current Assets) minus Current Liabilities.
Ideal result
Industry specific with no firm benchmarks, but as a very general rule of thumb, ROCE should be higher than bank interest rates. A return any lower than this suggests a company is making poor use of its capital resources.
Example of a company making efficient use of its capital resources
Bank Interest Rate: 12%
EBIT: 1,000,000
Capital Employed: 3,000,000
Result: ROCE Ratio = 33%
(This business is generating a return higher than the fixed investment yield).
Example of a company making poor use of its capital resources
Bank Interest Rate: 12%
EBIT: 150,000
Capital Employed: 3,000,000
Result: ROCE Ratio = 5%
(This business is generating a return lower than the fixed investment yield).
Note
Where the Earnings Before Interest and Tax is a loss, the Ratio will return a negative value.
Where the Current Liabilities exceed the value of Fixed Assets plus Current Assets, the Ratio will not be applicable as there is effectively a negative investment, which is not possible.
When this is the case, the following result will be displayed. CL>CA+FA.
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