What is a balance sheet? - MoneyWeek Investment Tutorials

so in today's video we're going to take a look at balance sheets now in a previous video we've looked at what is profit and a lot of investors look at profit and loss accounts and as long as profits Rising they think great this is a company I want to buy but actually that can be a mistake you need to look at the balance sheet as well uh it's not the most exciting document to read it's got a lot of numbers and a lot of jargon in it but without a balance sheet you can't really get a sense for what a business is may be worth and what it's therefore force a long-term prospects are so this video is all about what balance sheets are for and the very basic types of information you can expect to take away without getting buried in the jargon and the accounting buzzwords okay so where do they fit in uh well accounts basically can be divided into three important statements buried right in the middle of the 100 page document we call a set of accounts your find a profit and loss account a balance sheet and a cash flow statement so let's take a look at those first two in in essence what you've got is this every 12 months the directors will prepare a balance sheet as such it represents you freezing the business and taking almost a photograph of where it's at right now and you'll notice that balance sheets are prepared specific dates so for example you might have a balance sheet prepared at the 31st of December for a particular year say 2010 another popular one is the end of the tax year for companies so quite often you'll find 31st of March 2011 let's say the point is the directors pick a point in time um the end of the trading year if you're a retailer for example sort of around Christmas time let's say or the end of the tax here they're quite popular but certainly not the only options and you prepare a snapshot see balance sheets very much as taking a photograph at one point in time now as such it's a slightly artificial exercise balance sheets are out of date almost as soon as they're prepared because of course in reality businesses don't just stop they keep going nonetheless as a quick snapshot of what a business might be worth balance sheets can be quite useful and usually they're prepared at 12 month gaps uh to keep the accountants happy with possibly an interim statement somewhere in between say every 6 months or even every 3 months now just worth noting that although we're going to focus on balance sheets if this is a 12 Monon period um a profit and loss account is more of a story it tells the tale of how the business got from here to there and hopefully the answer is by making profits in other words the business grew so although this video isn't about profit and loss accounts see the profit and loss account as more like a cine camera capturing everything that's happened and summarizing it between two balance sheet dates then the balance sheet is a photograph so the language of profit and loss accounts is sales revenues minus costs to give you a profit it's a story Sal will have been made January February March April May and so on costs will have been incurred and they're just summarized for each 12-month period but really for a sense of what the business might be worth to an accountant let's say you want the balance sheet the snapshot so what is a balance sheet what makes it different to this thing the profit and loss account okay well basically balance sheets are simply quick snapshot statements of net worth so sounds very flash actually very simple as Tim Bennett I could draw up a personal balance sheet I could start to list right now what my assets are what I own um so a property some cash in my pocket uh and so on um then I've got some some things I owe other people so my net worth isn't my property because I'm forgetting there's a mortgage on it so actually if I sold my property tomorrow all the cash isn't mine I'm not going to sell it tomorrow but if I did um I'd have to pay back a mortgage first so actually the net bit I own is a bit smaller um and then perhaps I remember that I owe my mate 20 quid from last week down the pub so I've got to think about repaying him at some point that's called a liability an amount that I've got to pay back at some point even if I don't do it now um so I could start to think about my personal net worth in terms of the assets I own and some of them will be longterm and shortterm and the amounts that I owe other people some of those are short-term and longterm my mate's debt I I'll pay him back next week that'll be gone in a week but my mortgage that's not going to be gone for 20 years so some of my liabilities are short and long term too and my net worth is presumably the difference um and that'll increase or decrease depending on which day of the week you ask me to do it um and that's roughly what companies do a balance sheet is simply a statement if you like of what they own minus what they owe other people at let's say the 31st of March the difference is known not surprisingly as the net position and then at the bottom the reason they balance is you answer the question how has that net position been funded balance sheets balance because those two numbers should be the same in other words you can't conure net worth out of thin air be nice if you could but no one I've yet met can do it um in other words somebody has funded that net position so maybe I started my whole personal balance sheet as Tim Bennett um how did I ever go to a bank to afford a property perhaps my father gave me some money to get me going um and with that I put the deposit down on the property that allowed me to borrow and so on now companies don't have friendly dads who give them money well some do um but normally they have shareholders so how's the whole thing been paid for is normally called shareholders funds and the balance sheet balance is because the company's net worth is equivalent to what shareholders are put in plus any profits the company has made since it started so taking this a step further companies used jargon at this point to explain what they own but the jargon shouldn't put you off so for example they'll break their assets into fixed slightly confusing term and current in other words just like I did with my personal balance sheet back there uh companies own some things longterm fix doesn't mean nailed to the floor it means stuff we're going to keep for more than a year from the balance sheet date so it includes land and buildings plant Machinery vehicles that kind of stuff current assets short-term assets the stuff that if you did this exercise in a year's time it's probably all going to be be gone or at least have changed so cash stock stock in the sense of uh the stuff the company makes for example raw materials components lying around if it's a car manufacturer for example um and also receivables um so for example if you lend someone1 down the pub and you were to draw up a personal balance sheet that' be a little bit of a sad thing to do um they owe you the money in your books this would be the sad bit that will be a receivable and if you didn't think you receive it all you'd write some of it off uh anyway so companies have things called receivables as well within current assets so these are the sort of accounting headings that you start to see and also companies like to break what they owe to external creditors so banks for example and other lenders into shortterm um amounts due in less than one year and longterm amounts realistically we'll be paying it off in more than one year so for me you know an amount an overdraft for example is a short-term creditor it's an expensive way to fund a business long term it's an expensive way to fund Tim Bennett long term but a personal loan for me or a 10-year loan for a company that falls into creditors due in more than one year and that's just a bit of jargon um debtors or receivables are current assets that's people who owe us money creditors amounts that we owe other people um but nonetheless even if you break it down into four numbers those are positive because they're assets those are negative because they're liabilities used to end up with a hopefully net asset position now down here funding as it's called breaks down broadly speaking into share capital and profits in essence what we're saying is in the past in order to build the business the companies probably sold shares to external shareholders that funding is represented here as share capital and also over time hopefully the company's been trading profitably every 12 months that profit statement is positive and if you run a profit a positive profit statement for say 10 years since you started a business you'll have 10 years of accumulated profits assuming you haven't paid out dividends and all of that ultimately belongs to the shareholders of the business so the shareholders contribution sits at the bottom of the balance sheet and this is a simplification but it's split broadly speaking into amounts the shareholders have put in to fund the business and the accumulated profits that if the business was liquidated tomorrow so the theory goes they would receive now just going to finish with the reason balance sheets balance just to give you a flavor for that um they always balance and that's because accountants have a habit of recording everything twice which forces them to balance so what that means is when you look at a balance sheet that number is the same as that number or that number is the same as that number um and the reason is is simply this if for example I were to borrow 100 as an accountant I would raise my current assets by 100 cash and I'd also raise my current liabilities by 100 because I've got to pay it back at some point net effect zero or if I ask my shareholders for some more cash share Capital Rises to reflect their contribution by say 100 and cash up here Rises by 100 that's up a 100 that's up 100 the whole thing balances so this isn't the bookkeeping course but because accountants record everything twice balance sheets always Balan that doesn't matter too much what's more important is to realize that the top half represents net ownership of assets at a snapshot point in time and the bottom half represents how that's all been paid for now as an investor what are the takeaways from this number one don't just look at profit and loss accounts that's dangerous because a company may make a oneoff profits one year but but what about the longer term picture for that you need the balance sheet the balance sheet is also the place where you'll find hidden nasties that are simply not in the profit and loss account for example there's a note that supports the balance sheet called contingent liabilities it's written and it's quite a long way after the balance sheet and that reveals liabilities nasties so it's it's it's in this little section here that the company hasn't yet recorded on the balance sheet but become a problem in the future lawsuits for example outstanding at the balance sheet date and also if you're looking for what's the business worth whilst a balance sheet isn't fantastic because it's out of date and it's prepared according to accounting rules so assets are often recorded at the historic cost not always their current market value it's a good starting point a profit and loss account will not tell you what a company's worth it just tells you what one year's profitability looks like but a balance sheet is at least a starting point for getting a a handle on essentially the value of the entire business

Channel: MoneyWeek

Views: 398,280

Keywords: finance, educational, investing, money, moneyweek, Tim, Bennett, balance, sheet, sales, costs, profit, loss, P&L, net, funded, assets, current, fixed, share, capital, accounting, basics, Balance Sheet (Literature Subject), Market, Credit, Money (The Office)

Id: DuKEcxVplnY

Length: 13min 10sec (790 seconds)

Published: Fri Apr 15 2011