The Balance Sheet - Business Finance - ثاني ثانوي

Link to digitat econ 3.2 The Balance Sheet www.em.edu.sa Key Terms Balance sheet Assets Liabilities Shareholders' equity Current assets Long-term assets Inventory Accounts receivable Depreciation Current liability Long term liability Financial statement that Enumerates us of a point in time) whas aneconomic unit owns and Gwes and its net worth An executive manager at a company wants to always be aware of the financial situation of their company. One popular financial statement that communicates this is known as a balance sheet. A balance sheet is designed to communicate the current value of a company. It's a simple accounting of all of the company's assets, liabilities, and shareholders' equity, and offers analysts a quick view of how a company is performing and expects to perform (see Figure 3.2). FIGURE 3.2 The Three Key Components Balance sheet Shareholders' equity The my of a Balance Sheet Assets 38 Business Finance را فصلد Most balance sheets follow this basic formula: assets = liabilities + shareholders' equity. In fact, this formula is at the heart of almost all accounting (see Figure 3.3).

FIGURE 3.3 Total Total assets Total liabilities shareholders equity The Balance Sheet Equation An asset is anything the company owns which has a quantifiable value. This may include physical property (for example, vehicles, real estate, and unsold inventory), as well as intangible items (for example, patents and trademarks). Liabilities are things the company owes to someone else. Liabilities may include outstanding payroll expenses, debt payments, rent and utility payments, money owed to suppliers, taxes, and bond payments. Assets and liabilities are described in Figure 3.4. Shareholders' equity is a term that refers to the net worth of a company. It reflects the amount of money that would be left if all the firm's assets were sold and all the liabilities paid. This equity belongs to the company's shareholders, whether they are a private owner or public investors. (tems or property owned by am, household, or government and valued in monetary terms What an economic unit owes expressed in monetary terms Shareholen enuity A fum's net worth, the amount of money that individuals have invested in the firm, the summ of stock paid in capital, and retained earnings Assets Labilities Current Long-term Airreni Long-term Explo Le போற யய وزارة الصليدر * FIGURE 3.4 Asserts and Liabilities CHAPTER 3 Analysis of Financial Statements 89

CONJECKLE Short-term assets that are expected to be converted into cash during the fiscal year Long term usats Assets that are expected to be held for more than a year, such as plant and equipment Figure 3.5 presents a simplified balance sheet for Daana's Delights. This balance sheet (and the other financial statements presented later in this chapter) is published in the firm's annual report. The assets are divided into three groups: (1) current assets, which are expected to be used and converted into cash within a relatively short period of time; (2) long-term assets, which are those assets with a life span exceeding a year; and (3) other assets, such as investments in other firms' stocks. The liabilities and shareholders' equity are presented next, frequently on the right-hand side of the balance sheet across from the assets. Although it is not necessary for a balance sheet to be arranged in this manner, many firms use this general form which clearly enumerates the assets, liabilities, and equity of the firm. Daana's Delights had overall long-term and current liabilities of SAR 8,330,000 and equity of SAR 1,324,000 in 20X1. As noted, the sum of the liabilities and equity must equal the sum of the assets, for it is the liabilities and equity that finance the acquisition of the assets. The assets could not have been acquired if creditors and owners had not provided the funds needed to acquire them. In this example, the balance sheet indicates that liabilities finance 86.3% and that equity finances 13.7% (SAR 1,324,000/SAR 9,654,000) of the total assets. Thus, the balance sheet indicates the proportion of the assets financed with debt and the proportion financed with equity. L 90 IyrBusiness Finahceܡ

Balance Shoot 201 20x0 FIGURE 3.5 Our mat Daana's Delights Cash and cash equivalents 373,000 618,000 Balance Sheet Receivables 1,172,000 1,160,000 Inventory Prepaid expenses 1,235,000 1.380,000 125,000 140,000 Other current assets 37,000 28,000 Total current assets SAR 2,942,000 SAR 3,326,000 Long Time As Land Inot depreciated) Buildings Equipment Less accumulated depreciation Total property, plant, and equipment Other long-term assets Total assets Short-term debt Accounts payable Accrued salaries and wages Other accrued liabilities Income taxes 77,000 56.000 775,000 843.000 3,250,000 -2,130,000 3,500,000 -2,295,000 1,972,000 2,104,000 4.740,000 4.135,000 SAR 9,654,000 SAR 9,565,000 61,000 124,000 1,130,000 1,248,000 325,000 390,000 485,000 488,000 74,000 91,000 SAR 2,075,000 SAR 2,341,000 Total current liabilities Lime-five ties Long-term debt Deferred taxes 5.200,000 360,000 4,830,000 410,000 Other long-term liabilities 695,000 867,000 Total long-term liabilities SAR 6,255,000 SAR 6,107,000 Share capital Statutory reserve 125,000 57.500 125,000 57.500 Retained earnings Total shareholders' equity 1,141.500 1,324,000 934.500 1,117,000 Total liabilities and shareholders' equity SAR 9,654,000 SAR 9,565,000 وزارة التعليم CHAPTER 3 Analysis of Financial Statements 91

Two additional points need to be made about balance sheets. • First, a balance sheet is constructed at the end of a fiscal period (for example, a year). It indicates the value of the assets and liabilities and the net worth at that particular time. Since financial transactions occur continuously, the information contained in a balance sheet may become outdated rapidly. ■ Second, the values assigned to the assets need not mirror their market value. Instead, the values of the assets may be overstated or understated. For example, the firm owns accounts receivable, not all of which will be paid. Although the firm does allow for these potential losses in an effort to make the balance sheet entries more accurate, the allowances may be insufficient, and the value of the assets may be overstated. Conversely, the value of other assets may be understated. The land on which the plant is built may have increased in value but may continue to be carried on the company's books at its cost. Inventory What a firm has available to sell Accounts receivable Amounts of money that are due to be paid to a seller from a buyer 3.2a Assets Current assets While current assets are typically listed in order of liquidity (cash, accounts receivable, and inventory), the following discussion considers each asset in reverse order. Raw materials are first acquired and converted into finished goods. This inventory is then sold, at which time the firm receives either an accounts receivable or cash. Firms must have goods or services (or both) to sell. These goods are the firm's inventory. When goods or services are sold, the firm receives either cash or a promise of payment in the future. A credit sale generates an accounts receivable, which represents money that is due to the firm. Daana's has SAR 1,172,000 in receivables; this is a net figure obtained by subtracting the doubtful accounts from the total amount of receivables. Since a firm does not always obtain payment from all its accounts receivable, it is necessary to make an allowance for these "doubtful accounts." Only the net realizable figure is included in the tabulation of the firm's assets. A cash sale generates the asset "cash" for the firm. Since holding cash will earn nothing, some of it may be invested in short-term money Business Finance

instruments (often referred to as "cash equivalents"). Cash and short-term money instruments may be combined under a classification called cash and cash equivalents. For Daana's, cash and short-term marketable securities total SAR 373,000. This money is available to meet the firm's immediate financial obligations. Cash and cash equivalents, accounts receivable, and inventory are the major short-term assets. Other current assets include the "prepaid expense," which arises when an expense is paid before it occurs. For example, an insurance premium is paid at the beginning of the policy. The premium payment generates the asset, prepaid expenses. This asset is consumed (reduced) while the policy is in force, so at the end of the term of the policy, the prepaid expense account is reduced to zero. In 20X1, total current assets amounted to SAR 2,942,000. These short-term assets will flow through the firm during its fiscal year and will be used to meet its financial obligations that must be paid during the year. The total value and the nature of these assets are important in determining the firm's ability to meet its current obligations. Why is inventory classed as an asset rather than a liability? alin التعليم 64% 93

Depreciation The process of allocating the cost of the fixed assets over a period of time Long-term assets Long-term assets include the firm's property, plant, and equipment, which are used for many years. The firm's employees utilize these long-term assets in conjunction with the current assets to create the products or services that the company offers for sale. The type and quantity of long-term assets that a company uses vary with the industry. Some industries, such as utilities and transportation, require numerous plants and extensive equipment. Firms in these industries must have substantial investments in long-term assets in order to operate. Not all companies choose to own these assets; instead, they may rent them, which is called leasing. Regardless of whether the firm leases or owns these assets, it must have the use of the long-term assets to produce the company's output. As of the end of fiscal 20X1, Daana's had SAR 1,972,000 invested in buildings and equipment. This is a net number and includes the original investment in fixed assets minus depreciation. Depreciation is important because it is the process of allocating the cost of the fixed assets over a period of time. The value of long-term assets on a firm's balance sheet is reduced over time as the assets are used. Land is also a long-term asset and may be included in fixed assets. Unlike investments in plant and equipment, land is not depreciated but is carried on the books at its cost or purchase price. Land values, however, may increase, in which case the accountants could increase the land's value on the books. The remaining entry on the asset side of the balance sheet is "other long-term assets," which may include stock in other companies, goodwill, and intangibles. Even though stock in other companies may be sold and converted into cash, it is often considered separate from the firm's current assets and classified as a long-term asset. Goodwill occurs when one company buys another but pays more than the book value (the accounting value) of the acquired firm. For example, if company A buys company B for SAR 100 million but the book value is only SAR 60 million, then the acquiring firm accounts for the SAR 40 million difference as goodwill. Intangibles may include patents and trademarks. Business Finance

Total Assets The total assets are the sum of the current assets (SAR 2,942.000). and the sum of long-term assets (the property, plant and equipment) (SAR 1,972,000), and the other assets (SAR 4.740,000), a total of SAR 9.654,000 in 20X1. These assets are financed by the claims of creditors and stockholders- the firm's liabilities and equity. 3.2b Liabilities The firm's liabilities are divided into two groups: ⚫ Current liabilities must be paid during the fiscal year . Long-term liabilities are due after one year Current Liabilities Current liabilities are primarily accounts payable and short-term loans. Just as the firm sells on credit, it may also purchase goods and raw material on credit. This trade credit is short-term and is retired as goods are produced and sold, and receivables collected. Daana's had SAR 1,130,000 in accounts payable. Its short-term debt amounted to SAR 61,000. Additional current liabilities include accrued salaries and wages that have been earned, but not yet paid (SAR 325,000). Other accrued liabilities may include interest on the firm's outstanding debt and payments for the use of patents, as well as income taxes. As of 20X1, these current liabilities were SAR 485,000 and SAR 74,000, respectively. The sum of all the current liabilities was SAR 2.075,000. Long-Term Liabilities Long-term debt obligations must be retired at some time after the current fiscal year. Such obligations may include bonds that are outstanding and mortgages on real estate. These long-term debts represent part of the permanent financing of the firm because these funds are committed to financing the business for a long period of time. Short-term liabilities are usually not considered part of the firm's permanent financing because these liabilities must be paid within a relatively short period. Daana's has long-term liabilities that consist primarily of long-term debt (SAR 5,200,000 in 20X1). Commal liability Debt that must be paid during the fiscal year Long-term ability Debt that becomes due to be repaid after one year وزارة التعليم CHAPTER Analysis of Financial Statements 95

3.2c Stockholders' or Shareholders' Equity Stockholders' (or shareholders') equity completes the balance sheet. The initial entry is share capital (SAR 125,000). The next entry is for statutory reserve (SAR 57,500). Next is the retained earnings (SAR 1,141,500), which represents the firm's earnings over time that were not distributed to the shareholders. 2135 2946 26,5147 ,8596 43,1876 2,2131 42,5849 3,9515 A 64,517 1,154838,58 2,8197 +2,9516 21,1 24,5 12,18 -1,936,41 +253 2021-144 145 A 26,5 Why do you think shareholders' equity included on a balance sheet?