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How to Read & Understand a Balance Sheet
The profit and loss statement of a company only gives you information on the incomes, expenditures, and overall profitability of a company. The balance sheet, on the other hand, tells you just how much a company owns and owes. It gives you complete information on all the assets and the liabilities of the company, including the details of its share capital.
There are two parts to a balance sheet:
- Equity and liabilities
If you take up the balance sheet of a company, you’ll always find that the value of the assets equals the value of the equity and liabilities. This is the true essence of a balance sheet. In fact, there’s a logical reason why the assets are always equal to the equity and liabilities in the balance sheet of a company. You see, all the assets that a company owns have to be funded either through borrowings (liabilities) or the share capital only, right? Therefore, both the sides are always equally ‘balanced.’
Reading through the balance sheet of a company
Just like we did in the two previous chapters, we’ll take up the balance sheet of Hindustan Unilever Limited for the year 2019-2020. Take a moment to read through the balance sheet and familiarise yourself with the layout and the structure.
Since the layout and the structure is similar to the P&L statement, we’ll get directly to the crux of the matter. Let’s take up each section of the balance sheet and try to understand the terms and their meanings, starting with the assets side.
The assets side of a balance sheet consists of two primary categories
- Non-current assets
- Current assets
Let’s delve a little deeper into these two.
Also known as long-term assets, these are the assets that are held by a company for more than a year. Non-current assets cannot be easily or quickly converted to cash. In the balance sheet of HUL, you can find the following non-current assets.
Property, plant and equipment
This line item consists of all the fixed assets such as land, buildings, plant and equipment, furniture and fixtures, and other office equipment owned and leased by the company. Note 3 of the financial statements goes into further detail with respect to these assets. Here’s a snapshot of the relevant note.
Note 3 also gives you a detailed breakup of the assets owned and leased. It classifies these fixed assets according to their nature. Also, the note contains detailed information about the new purchases made during the year, the disposal of assets via a sale, and the value of depreciation for the assets. Take a look at these details.
Capital work-in-progress (CWIP)
All of the costs associated with the production or construction of a fixed asset are classified as capital work-in-progress (CWIP). For instance, all the costs incurred on the construction of a building by the company is termed as capital work-in-progress.
Goodwill and other intangible assets
Goodwill is essentially the reputation built by a company over the many years of its existence. It is generally quantified and disclosed as an intangible asset in the balance sheet of a company. Similar to ‘property, plant and equipment,’ the in-depth details of goodwill and other intangible assets are specified in note 4 of the financial statements.
Here’s a snapshot of this note.
Financial assets consist of all the long-term investments made by the company in its subsidiaries, associate companies, and joint ventures. In addition to that, long-term deposits, financial market investments, and loans issued to other companies are also included. Notes 5 through 8 gives you in-depth information about all the non-current financial assets owned by the company.
Non-current tax assets and deferred tax assets
All the long-term assets that can be utilised by a company to reduce its taxable income at a future date are classified either as non-current tax assets or deferred tax assets. For instance, overpayment of taxes or advance payment of taxes are classified as non-current tax assets, since they can be used to reduce the tax liability of the company at a future date.
Other non-current assets
All the other ancillary and miscellaneous long-term assets that cannot be classified under any of the above-mentioned categories are typically categorised under other non-current assets.
The assets of a company that are expected to be converted to cash within the span of one year are generally classified as current assets. They’re also known as short-term assets, and they can be easily sold or converted to cash. In the balance sheet of HUL, you can find the following current assets.
The stock of goods and materials that a company holds is generally categorised as inventories. Inventories can be anything from raw materials and packing materials to work-in-progress and finished goods. Note 11 of the financial statements of HUL gives you a detailed breakup of all the inventories held by the company in the current year.
Unlike non-current financial assets, these financial assets consist of all the short-term investments held by a company. It includes short-term financial market investments, bank balances, cash balances, and trade receivables.
Trade receivables are essentially products sold by a company, for which the payments are yet to be received. In the case of HUL, notes 6, 8, 12, 13, and 14 go into the details of the current financial assets owned by the company.
Other current assets
All the other ancillary and miscellaneous short-term assets that cannot be classified under any of the above-mentioned categories are typically categorised under other current assets.
Assets held for sale
Non-current assets that a company hopes to dispose of by selling them within the period of one year are categorised as assets held for sale. Such assets are reclassified by shifting them from the non-current assets section to the current assets section.
All of the values in the ‘assets’ side of the balance sheet are then summed up and indicated as ‘total assets.’
Equity and liabilities
The equity and liabilities of a balance sheet consists of three primary categories.
- Non-current liabilities
- Current liabilities.
Let’s delve a little deeper into these three.
The equity header consists of the following two subdivisions.
- Equity share capital:
It shows the total paid up value of the equity share capital of a company. A detailed breakup of the equity share capital including the number of authorised equity shares, the number of issued and paid up equity shares, and the face value of the shares can be found in the notes to financial statements section.
- Other equity:
It consists of other equity balances such as securities premium and outstanding employee stock options. All the other reserves of the company such as capital reserve, capital redemption reserve, and retained earnings also appear under this tab. A summary of the various items under the ‘other equity’ tab of the balance sheet can also be found under the notes section.
Similar to the assets side of the balance sheet, the liabilities section also consists of two sub-categories:
- Non-current liabilities
- Current liabilities
Here’s a brief look at these two items.
All the financial obligations of a company that are not expected to be paid off over the course of one year are classified as non-current liabilities. Non-current liabilities cannot be easily or quickly settled. In the balance sheet of HUL, you can find the following non-current liabilities.
These financial liabilities are long-term debt obligations owed by a company and are required to be repaid. Ancillary and miscellaneous financial liabilities such as lease liabilities, employee related liabilities, and security deposits are all typically classified under other financial liabilities.
A company typically makes a provision for an existing or present liability in its books of accounts. These provisions are then supposed to be paid off by the company in the future. All the long-term provisions are classified under this tab of the balance sheet.
Non-current tax liabilities
Non-current tax liabilities consist of long-term tax liabilities that are required to be borne by the company, but have not yet been paid.
The liabilities of a company that are expected to be repaid within the span of one year are generally classified as current liabilities. They’re also known as short-term liabilities and are typically repaid within a year. In the balance sheet of HUL, you can find the following current liabilities.
Unlike the non-current financial liabilities, these financial liabilities consist of all the short-term liabilities owed by a company. They also include trade payables, which are essentially payments that are due to the suppliers of a company.
Also, ancillary and miscellaneous short-term liabilities such as unpaid dividends, salaries, wages, bonus, and current lease liabilities are all typically classified as other financial liabilities.
Other current liabilities
Current financial obligations that cannot be classified under any of the above-mentioned categories are typically categorised under other current liabilities. Customer advances and statutory dues such as tax deducted at source (TDS) and provident fund payments generally appear under this head.
All the short-term and current provisions are classified under this tab of the balance sheet.
The values in the ‘equity and liabilities’ side of the balance sheet of a company are then summed up and indicated as ‘total equity and liabilities.’
These numbers hold a lot of significance, and they can be used to calculate a number of ratios that give you a better idea of where a company stands and where it’s headed. These balance sheet ratios are a key part of fundamental analysis. And in the next chapter of Smart Money, we’ll be getting into the details of these numbers.
A quick recap
- There are two parts to a balance sheet: assets and liabilities.
- The assets side of a balance sheet consists of two primary categories: non-current assets and current assets.
- Also known as long-term assets, non-current assets are the assets that are held by a company for more than a year. They cannot be easily or quickly converted to cash.
- Non-current assets include property, plant and equipment, capital work-in-progress, goodwill and other intangibles, financial assets, and non-current tax assets, among others.
- The assets of a company that are expected to be converted to cash within the span of one year are generally classified as current assets. They’re also known as short-term assets, and they can be easily sold or converted to cash.
- Current assets include inventories, financial assets, other current assets, and assets held for sale.
- The equity and liabilities of a balance sheet consists of three primary categories: equity, non-current liabilities, and current liabilities.
- The equity header consists of the following two subdivisions: equity share capital and other equity.
- All the financial obligations of a company that are not expected to be paid off over the course of one year are classified as non-current liabilities. Non-current liabilities cannot be easily or quickly settled.
- Non-current liabilities include long-term financial liabilities, provisions, and non-current tax liabilities.
- The liabilities of a company that are expected to be repaid within the span of one year are generally classified as current liabilities. They’re also known as short-term liabilities and are typically repaid within a year.
- Current liabilities include short-term financial liabilities and current provisions.