Balance Sheet Continued 215

Corporate Finance PowerPoint presentation. In this presentation, we will go into more detail about the balance sheet. Get ready, it’s time to take your chance with corporate finance, balance sheet continued. Remember when we’re thinking about the financial statements, we can break them out to two separate objectives. If we’re considering this from an investor standpoint, that is, where does the company stand at a point in time, and what’s the likelihood or their earnings potential in the future, which we will typically based on past performance, therefore, you’re going to have the timing statement and the point in time type of statement. So when we think about the balance sheet, that’s going to be the point in time type of statements. So if you’re looking at the financial statements for the year ended December 31, the balance sheet will be as of the end of the period, in this case, December 31, as opposed to the timing statements, which are going to be the income statement being the primary statement that should come to mind measuring performance, which will be as of January through December 31 measure and how well we did for that range of time. So our focus over here is going to be on the balance sheet.


Where do we stand at this point in time. So remember, when we think about the balance sheet, we have the balance sheet, we have the income statements going to look like this, we’ve got the statement of retained earnings, and the statement of cash flows. You can see the interrelationship between these statements. By seeing that the balance sheet is where we stand at the end of the timeframe, such as December 31, it ties into the income statement, because the income statement is breaking out the performance, which you could think of as basically the equity section because the balance sheet represents assets minus liabilities, equals the equity section retained earnings is going to be the component in the equity section, where we break out performance how we’ve done, such as how we did last year, so we can break out last year, which will be represented by the income statement revenue minus expenses. And we have the preferred stock given us the earnings available to common stockholders in this example, we’ll talk more about that later.



And then we have the statement of retained earnings, which is going to tie in the income statement to the balance sheet, that’s gonna that’s going to be how they’re linked together, the statement of cash flows, you can kind of think of as taking these balance sheet or these financial statement items, and reformatting them from an accrual basis, basically, to a cash flow basis to see a cash flow statement. So you want to see these three as a link, or these two as linked and then the retained earnings or the statement of retained earnings as the linking factor. And then the statement of cash flows is something you would typically prepare afterwards, reworking the numbers that we have over here in a format that would be on a cash flow basis, as opposed to an accrual basis. So the balance sheet what the company owns, which are the assets and how they are financed. So from a corporate finance perspective, we can think about how the company is financed.



What is the financing of the company, meaning? How does the acid structure kind of composed, it’s either financed through liabilities, or equity, that’s the accounting equation. Assets is what the company has, and who do they owe those assets to, or who has claimed to those assets, the other side of the coin being the same, right, it’s the same total amount being liabilities, third party went to a third party and equity, how much is owed to the owner. So it’s going to be stated as of a point in time. So that’s really key, because you want to think whenever you look at the financial statements, you’re gonna like, let me look at last year’s financial statements.



If they give you last year’s financial statements, Indian, or January through December, when you look at the balance sheet, you’re really looking at the balance sheet as of December 31, the end of the period. So you’re not looking, if you were to say, give me a last year’s balance, give me a last year’s balance sheet. And give me last month’s balance sheet, you had basically have the same balance sheet because both of those periods, although they have a different beginning point and on December 31. And the balance sheet is as of a point in time shows the company’s holdings and obligations, what the company has, and who they owe those those items to. And items will generally be shown at original cost basis rather than market value. So notice, that’s going to be a convention of the accounting that we will be using most of when you’re thinking about financial statements for a publicly traded company, they will typically be in alignment with an accrual principle and they will typically be in alignment with standardized policies such as generally accepted accounting principles, part of those standardized policies will have to do with how we’re going to value certain items on the balance sheet. I’ll get into that in a little bit more detail.



But that’s one of the kind of like the limitations or the things that we have to consider when we’re considering the balance sheet and how we’re going to value the company based on it. So here we have the balance sheet. So the best way to kind of break this out is to go through the balance sheet. We did a little bit of this in a prior presentation. So I’ll go through it a little bit more quickly here but just know this is kind of a format of the balance. sheet that we will be working with most of the time in the in the course. And that and part of the formatting of this balance sheet is that it’s for a corporation. So for a corporation, just note that the most confusing part of the balance sheet oftentimes is the equity section, this equity section to the right, because the equity section could differ based on the type of entity.



So if you’re dealing with finance, and you’re always dealing with publicly traded companies, that’ll it’ll be similar because you’re always dealing with a cover company type of entity. However, you can have a similar thing, if you’re a sole proprietorship, a very small company could have the same type of layout as well as a partnership, the only thing that will differ, you’ll still have the assets and the liabilities, but the equity section, the equity section in total, you can always think as basically the same kind of thing the equity section represents basically the claim to the assets that the owners have. The difference is who are the owners? How are we breaking out the owners, if you think about a sole proprietorship, one person having one company, then you this equity section wouldn’t be called stockholders equity, because the stockholder isn’t the owner, it’s just the owner’s equity. And it would just be one number, and the company, the whole thing would be owned by the owner.



And so no problem pretty, pretty straightforward, you can just basically take this whole thing and distill it down to the total of it. And that would be like what would be reported in a sole proprietorship? partnership is a little bit more difficult, because you could have two or more partners. So let’s say you have three partners, then the stockholders equity represents the ownership of the company, the ownership total is is the same could be the same number here if it were a partnership, because that’s how much it is owned by the basically the owners, in this case partners. But now you can’t say it’s just one person like a sole proprietorship. And it’s not going to be broken out like a company, but rather, it’s going to be broken out by the owner.



So now you got to basically say, here’s my three owners, and here’s the amount of the owner’s equity that’s been allocated to those three. Now that you would think like a partnership might be easier than a corporation. But in some ways, it’s more difficult, because there’s a lot of variation that you can have within the profit sharing of a partnership. So they don’t have to split the ownership evenly one third, one third, one third, for example. And they can also vary in the amount of distributions they have, from the partnership in terms of withdrawals that they take over the time period. So the partnership can actually be quite complex. And and that’s one of kind of the prot, that’s one of the benefits, and one of the problems of a port of AI partnership. Because when you value the partnership, when you value a partnership interest, you’re not just taking a standardized unit of the company, and that you can compare to any other standardized unit of the company, you’re saying, hey, this partner has a 30% interest. And this is their profit sharing.



And this is how much time they’re supposed to spend according to the partnership agreement. It’s a lot more complex to figure to figure out now if you go to the corporation now, which is what we’re going to be working on. Once again, the total will be the same, you’ve got the 1,000,220 because that is what is owned, or how much of the assets are claimed by the owner still. So the total is the same. The question again, who are the owners? Well, if it was a partnership, it would be partners equity, right, and then it would list out the three partners or however many partners there are. And Corporation, it’s going to be stockholders equity, the stockholders are the owners of the company. Now the stockholders being the owners is once again, both simpler and more complex has both advantages and disadvantages.



So one of the advantages of a corporation is the standardization of the units of ownership. So the standardization of the units of ownership makes it one easier to trade and to easier to allocate the value of the corporation to standardize units, you’re not trying to allocate it to the to the rights that one partner has in a partnership agreement, you’re saying, hey, look, they’re all the same, all units are the same. So you can take them the book value of the company, and you can basically allocate the book value to the number of shares outstanding, and they’re all basically the same. So that kind of standardization is a lot easier. Now, if you look at if you look at the corporate stockholders equity, you can say what doesn’t look easy, it’s the most complex looking equity section that you look at.



But if you break it down, it’s it breaks down kind of like this, it breaks down instead of me breaking down individual owners and trying to see what they own. We’re gonna break it down by what was invested by the owners versus what the the company has generated through revenue through business, and yet has not yet distributed. So that means that if you have preferred stock and preferred stock, so a little bit more confusing, we’ll talk about it later. But just remember that preferred stock doesn’t mean it’s better than common stock. Preferred stock means that typically the general rule is preferred stock means that you’re going to get paid first with regards to the dividends that are owed. So if you declare dividends, they get paid first, which is why it would be preferred But you don’t typically have the voting rights that you have for common stock, therefore you have no influence, you’re not really so that for that reason, you really think of the common stock as the owner. So when you think about stocks, you’re typically thinking about common stocks.



Those are typically considered the owners. Those are the people that can vote for like the board of directors, that will then be hiring management, therefore, they have influence over the corporation. So but either one of these the preferred stock in the common stock, what would happen is, that’s when the company issues stock to the owners. So the owners put an initial investment into the company, just as you would for a sole proprietorship, for example, the sole proprietor might take money out of the personal account, put it into the business account, that would be represented in the equity section, under you know, the owner’s equity section for a sole proprietorship, how is that done in a corporation, the owners put money into the company in exchange for stock, right, the stock is going to go into the company, now it gets a little bit more confusing in that the stock will typically have a par value. Now, why would the stock have a what is the par value mean?



That note the par value is not the market value, the par value is a set value, usually less than one usually between like one and $10, one in $5, even. And the point of it, or one is that if you have a value that’s less than the market value, then you can standardize the number over here. So in other words, if I have 120,000, in common stock, and I have set a par value to be $1, than I know, I have 120,000 shares that are out there. So it’s an easy way for us to kind of standardize things, that doesn’t mean we’re actually going to distribute the shares. However, for $1, we’re gonna distribute them for whatever the value of the shares may be. So that means that when people buy shares, they’re going to they’re going to, we’re going to set this at the par value $1.



And anything in excess of the par value, we’re going to put into another account called capital paid in excess of par, or otherwise, no one has additional paid in capital. So in other words, these two accounts represent the investments of the owners, the shareholders into the company for the purchasing of common stock, this represents the investment of the owner into the comedy for preferred stock, which is still going to be here in the equity section. But note, the preferred stock doesn’t really have the same kind of voting rights as the common stock. So we typically, even though they get paid first with a dividend, they have a claim to the equity, to the to the value of the company going up when we make net income, or when we declare a dividend, which is, which is a payback or some of the earnings that the company has earned.



Generally, they get paid first, that’s the benefit. But again, you typically think of the common stock holders as basically the owners, then we so this, so this whole thing here is, is basically what the owners put into the company, right, that’s their investment that they invested in exchange for shares, then the retained earnings represents the amount of earnings that the company has actually generated. So this is performance of the company, what they have done over the entire life of the company, less what they paid out in the form of dividends, which are kind of like draws. In other words, if you are sole proprietorship, your sole proprietor you own, you’re the owner of the business, then you expect them to put in an initial investment, possibly, and then you’re hoping that the company will then earn money.



When the company earns money, it’s going to it’s going to accumulate assets, such as cash, which you will then take out in the format of draws. So those are called draws for sole proprietorship, when you’re taking money out of the company. For a corporation, then we call those dividends, we call them dividends. Now it’s a little bit different because for a corporation, the owner of the corporation, if I own one stock, I cannot force the company to pay me as I can, if I’m a sole proprietorship, I can’t say, hey, I want some of the earnings of the company, I want you to pay me I can’t do that. Why? Because the benefit of the corporation is that they’re all the same, the stocks are all the same. You can’t just pay one stockholder and not the entire stockholders that are out there. Otherwise, they wouldn’t be the same in the rights. So what happens on on a corporation is that the board of directors and management needs to decide if they’re going to be distributing some of the earnings in the form of dividends. And if they decide to distribute the earnings in the form of dividends, then they have to distribute an equal amount based on the type of shares that are out there paying the preferred stock first, and then the common stockholders.



So the so from a from a basic standpoint, whether it’s a sole proprietorship or an owner, you have the choice when you start to generate revenue in the company. When you start to generate revenue and accumulating earnings that the company has made through business. Now their assets will be going up because of those earnings. You can either keep those earnings in the business, and hopefully help them increase the amount of assets You have in total in the business, which hopefully will help you generate more money in the future. Or you can take those earnings and you can distribute them to the owners. In the case of a sole proprietorship, that would be a draw, but the owner would just take the money out, or in the case of a corporation, that would be in the form of a dividend, which the board of directors and the management of the company would have to agree to, so that they can pay those dividends out equally over all the stocks that are in place. So this is where I really want to kind of focus that’s the that’s the main difference. here between a corporation partnership owner equity, usually one of the most common common kind of problem areas.



So the standard breakout, as we seen in a prior presentation of the balance sheet is going to be the assets, liabilities and equity, the assets are going to break down will typically break them down further into current assets. Current Assets are those that are going to be more liquid in nature closer to cash, things that we can consume sooner than we have long term assets, which might be something like investments that we tip that we plan on holding on to longer. Oftentimes, there might not be any other long term investments other than property, plant and equipment, which could be called depreciable, assets, property, plant and equipment, pp. And E, you might hear called different types of things. But those are going to be those long term assets, such as buildings, such as equipment, those things that when we purchased them, we put them on the books as an asset, and then we will depreciate them over time allocating the cost to the time period in which we have consumed them. So we’re going to have the assets, then less accumulated depreciation that’s going to give us the total plant and equipment, our total assets down here.



Remember, the valuation of the assets that we have, whether they be cash or not, will be valued in dollars. In other words, we’re not going to value a building as one building, right, and then we have to somehow value it in dollars. Now remember that that’s one of the drawbacks, or one of the things we have to understand when we when we value the company. And it is especially important when you think about something like buildings, right, or property, plant and equipment. For example, if I have some office buildings here in the property, plant and equipment, we put them there at cost, and then we’re allocating the cost over the useful life. And from an investment standpoint, you might say, Well, I don’t want it at cost. What I’d like to know is what the market value is of the proper of the building, tell me what the market value is, because that’s what I need to know in order for me to value the financial statements and make decisions on them. However, there’s arguments on both sides as to whether you should revalue something like property, plant and equipment at the market value or not.



And it causes kind of fluctuations when when you do so, one of the major reasons we we don’t do it, or one argument against not doing that is the fact that things like it, like a building is unique. There’s no other building in the world, that’s like one other building, right? It’s completely different. Now you can kind of appraise the building, and try to figure out what the value is. But until you actually sell it on a market, you don’t really know what it is. And if you were to appraise the building and assign it a value that is that is kind of random or that is approximated, then you’re allowing, you’re allowing an ability to for companies to possibly appraise higher or lower typically, you can imagine the appraisals being higher, right? Because if it’s an estimate, you can on something that’s so big and could be influential, you can imagine companies looking for appraisers praises that will appraise towards the upper end of the estimation process. So that’s one reason that that a lot of times we will we will still use cost for some of these some of these type of items. So when we’re valuing the company, we’re gonna say, Well, yeah, that building was purchased 10 years ago, it’s worth more now.



And you have to be and that’s, that’s kind of a problem with the balance sheet that you’ll have to basically consider when you’re trying to value the company. And again, it’s inherent to the accounting. If you’re if you had something like cash, obviously, cash is cash, it’s at current value. receivables Can you can say pretty much current value inventory becomes more of a problem. But if it turns over a lot, it’s going to be basically current value. But when you get down here to like property, plant and equipment, then you’re gonna have to, you’re gonna have to think about, okay, that’s at cost, what’s the current value of it. Then we got the total assets down here, we’ve got the liabilities, which will typically be broken out into current liabilities and long term liabilities, the current liabilities are those that are going to be due within one year, and therefore that’s going to help you with liquidity. That’s why we break that out, meaning Do we have enough assets, especially cash, are we going to get cash soon so that we can pay off our current obligations that will be due in a year?



Can we pay them off, we got the long term liabilities, total liabilities, and then the stockholders equity. So just remember that we can see this from an accounting equation as two sides of one coin One side being total assets what the company has the other side being who has claims to those assets, either third party liabilities, or stockholders equity. From a finance standpoint, we will also we will often break this down when making decisions to the accounting equation being assets minus liabilities will equal the equity, meaning the equity represents the book value in the company. And that’s often the useful number, because that’s our jumping off point or our starting point when we’re trying to value the company. So if we look at all this connected, notice that the balance sheet could be vertically seen as well.



So you might see it in the format of side by side, you might see it vertical, you could see some different conventions with the indentation on the balance sheet, but it will typically have the same or these similar categories that we have meaning current assets and current liabilities and property, plant and equipment or some form of property, plant and equipment, meaning it might be just equipment or depreciable assets, but that will be broken out. And then I mean, you could have multiple columns and whatnot. And we’ll talk about a look at some of those different like look and feel of the balance sheet in future presentations, a few of them, when we when we actually start to build the balance sheet. But here you can still see the assets equal liabilities plus equity, you might have to just dig and look a little bit more if you get used to seeing a balance sheet and a side by side format and you see a vertical one, it kind of throw you off for a little bit. But once you get used to it, you’ll be able to pick those up.



So also remember that the income statement is related to the balance sheet. So the income statement is performance. And it ties into the equity section. Because the balance sheet, you can think of it as assets minus liability is the book value of the company, the income statement is the performance last year. So it’s not telling us the performance since the whole life of the company, just last year’s performance. Therefore, we have to then tie out the performance of last year to where we stood at the beginning of last year. Right. So we have to then take a look at the statement of retained earnings, which will tie that out meaning that will give us the beginning retained earnings, meaning you know our beginning point our beginning value, assets minus liabilities or the poor or the portion of equity that is representing the accumulation of revenue that has not yet been distributed last, you know in the prior period.



And then we’re going to add to it basically the net income or the earnings available to the to the stockholders subtract out the dividends, which is us the company giving the money back to the owners, kind of the dispersment kind of like a draw for a sole proprietorship, and that gives us then the retained earnings, that’s going to tie out to the balance sheet. So you want to think about the balance sheet and the income statement. You want to see how they fit together. Because the balance sheet is the double entry accounting system it is assets equal liabilities plus equity, the income statement is not outside of that system, the income statement fits into that system. Because it’s basically giving you the detail given you the story of the equity section of the value. It’s telling us how we got from January to December, in terms of the book value of the company, and then the statement of cash flows, you want to think about that as a bit different statement, which is going to be taking the information on the financial statements, reworking it from basically an accrual basis to a cash basis.



And you could see on the balance sheet bottom line of the balance sheet you will see a bottom line of a statement of cash flows will be tied to the cash on the balance sheet. So this is once again telling us a story about cash we’re going back if it’s a year if it’s for the year ended, we’re telling a story about the flows of cash that happened in the prior year which will end at this point in time the balance sheet number which will be cash out on the balance sheet representing cash as of the end of the period in this case typically been for a year end December 31


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