Balance Sheet Review 1 Dr. Craig Ruff Department of Finance J. Mack Robinson College of Business Georgia State University © 2014 Craig Ruff

Balance sheet is a summary statement of what the company owns and owes at a specific point in time. Balance Sheet… 2 ASSETSLIABILITIES CashNotes Payable Net Accounts ReceivableAccounts Payable InventoriesAccrued Expenses Total Current Assets Current Portion of Long-Term Debt Total Current Liabilities Gross Fixed Assets (less Accumulated Depreciation) Long-Term Debt (excluding the current portion) Net Fixed AssetsTotal Liabilities Total Assets EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff

Balance Sheet… As with the basic income statement, you need to make sure that this basic balance sheet is firmly in your mind. 3 ASSETSLIABILITIES CashNotes Payable Net Accounts ReceivableAccounts Payable InventoriesAccrued Expenses Total Current Assets Current Portion of Long-Term Debt Total Current Liabilities Gross Fixed Assets (less Accumulated Depreciation) Long-Term Debt (excluding the current portion) Net Fixed AssetsTotal Liabilities Total Assets EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff

Balance Sheet… Remember: It is a balance sheet: the two sides have to balance. Total Assets = Total Liabilities + Shareholders’ Equity Remember: It is a stock measure; it is a picture at one point in time. Remember: Generally, the items on the balance sheet are listed in order of liquidity. 4 ASSETSLIABILITIES CashNotes Payable Net Accounts ReceivableAccounts Payable InventoriesAccrued Expenses Total Current Assets Current Portion of Long-Term Debt Total Current Liabilities Gross Fixed Assets (less Accumulated Depreciation) Long-Term Debt (excluding the current portion) Net Fixed AssetsTotal Liabilities Total Assets EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff

5 Assets

Balance Sheet… Cash is the most liquid asset. Often, it is mainly in the form of demand deposits at banks. Cash may be ‘restricted’ (loan covenants), ‘spent’ (declared dividends) or ‘non-US.’ Cash might also include very-short term securities (T-bills, commercial paper). 6 ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff A demand deposit is an account at a financial institution (bank, savings and loan, credit union, etc.) that can be withdrawn immediately. In other words, you do not have to give your bank advance notice that you are withdrawing the money.

Balance Sheet… Net Accounts Receivable occur when a company sells a product but has not yet received the cash from the customer. Simply put, the accounts receivable represent money owed to the company by customers. Net Accounts Receivable = Gross AR – Allowance for Doubtful Accounts. 7 ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff

Balance Sheet… Inventories Generally take three forms: raw materials, work in process, finished goods. Also, the different costing approached (such as FIFO, LIFO and average cost) lead to different COGS and inventory values on the balance sheet. Here, we generally won’t worry about the different types of inventory. And we typically just use the straight-line form of depreciation. 8 ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff

Balance Sheet… Total Current Assets are referred to as ‘current’ assets as they are generally expected to be converted into cash within one year. 9 ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff

Balance Sheet… Fixed Assets includes equipment, building, vehicles, etc. that are generally of a permanent nature and required for the operation of the business. For this class: Gross Fixed Assets is the original historic cost of the asset. Accumulated Depreciation is nicely named: it is the depreciation that has accumulated on the asset to that point. Net Fixed Assets represents what the asset is really worth from an accounting perspective. We would refer to this as the ‘book value’ of the assets. 10 ASSETS Cash Net Accounts Receivable Inventories Total Current Assets Gross Fixed Assets (less Accumulated Depreciation) Net Fixed Assets Total Assets © 2014 Craig Ruff

11 Suppose the company buys a metal lathe for $1,000,000. The lathe is expected to have a useful life of five years and zero salvage value. © 2014 Craig Ruff

12 t=0 Day it is Purchased Annual Depreciation Expense Gross Fixed$1,000,000 Accumulated Depreciation Net Fixed$1,000,000 Suppose the company buys a metal lathe for $1,000,000. The lathe is expected to have a useful life of five years and zero salvage value. © 2014 Craig Ruff

13 t=0t=1 Day it is Purchased End of One Year Annual Depreciation Expense $200,000 Gross Fixed$1,000,000 Accumulated Depreciation $200,000 Net Fixed$1,000,000$800,000 Suppose the company buys a metal lathe for $1,000,000. The lathe is expected to have a useful life of five years and zero salvage value. © 2014 Craig Ruff

14 t=0t=1t=2 Day it is Purchased End of One Year End of Two Years Annual Depreciation Expense $200,000 Gross Fixed$1,000,000 Accumulated Depreciation $200,000$400,000 Net Fixed$1,000,000$800,000$600,000 Suppose the company buys a metal lathe for $1,000,000. The lathe is expected to have a useful life of five years and zero salvage value. © 2014 Craig Ruff

Suppose the company buys a metal lathe for $1,000,000. The lathe is expected to have a useful life of five years and zero salvage value. 15 t=0t=1t=2t=3t=4t=5 Day it is Purchased End of One Year End of Two Years End of Three Years End of Four Years End of Five Years Annual Depreciation Expense $200,000 Gross Fixed$1,000,000 Accumulated Depreciation $200,000$400,000$600,000$800,000$1,000,000 Net Fixed$1,000,000$800,000$600,000$400,000$200,000$0 © 2014 Craig Ruff

16 © 2014 Craig Ruff Liabilities and Equity

17 ASSETSLIABILITIES CashNotes Payable Net Accounts ReceivableAccounts Payable InventoriesAccrued Expenses Total Current Assets Current Portion of Long-Term Debt Total Current Liabilities Gross Fixed Assets (less Accumulated Depreciation) Long-Term Debt (excluding the current portion) Net Fixed AssetsTotal Liabilities Total Assets EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity © 2014 Craig Ruff

Notes Payable often represent short-term borrowing from a bank, perhaps to fund accounts receivable and inventory. 18 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Accounts Payable represent purchases by the company that the company has not yet paid for. Since this is money owed by the company to its suppliers, it is a ‘debt’ and a liability. 19 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Accrued Expenses represent expenses that have been ‘expensed’ on the income statement but not yet paid for by the company by the end of the closing period. As an example, suppose a company pays its employees in early January for work they did in the last two weeks of December. At the end of the year (December 31), the accountant will ‘close out the books’ and record the (not- yet-paid) wages as an expense on the annual income statement. Since the wages have been ‘accrued’ and not yet paid, the accountant will reflect the company’s obligation (debt) to the employees as an accrued expense on the balance sheet (in, say, ‘wages payable’). When the company actually pays the employees in January, the accountant will lower cash (on the asset side) and lower wages payable on liability side. 20 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

21 Suppose a company’s employees have generated $10,000 of wage expense in the last two weeks of December. It is now, December 31 st … © 2014 Craig Ruff

Current Portion of Long-Term Debt represents the portion of long-term debt due within one year. 22 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Total Current Liabilities are generally expected to be paid off in one year. 23 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Long-Term Debt represents liabilities that mature in excess of one year. 24 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Preferred Stock is a form of equity that has both debt- and equity-like features. Often, it is described as a “hybrid.” Common Stock represents the owners’ initial investment in the company. Retained Earnings represent the cumulative total of all net income that has been reinvested in the company. 25 LIABILITIES Notes Payable Accounts Payable Accrued Expenses Current Portion of Long-Term Debt Total Current Liabilities Long-Term Debt (excluding the current portion) Total Liabilities EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff

Common Stock is often broken into two pieces: 1) Common stock at par 2) additional paid in capital This division into two pieces is artificial and meaningless; it is the sum of the two pieces that matters. It is the sum of the two pieces that represents the book value of the owners’ initial investment. 26 EQUITY Preferred Stock Common Stock Retained Earnings Total Liabilities and Equity Balance Sheet… © 2014 Craig Ruff EQUITY Preferred Stock Common Stock at Par Additional Paid in Capital Retained Earnings Total Liabilities and Equity

27 Amount of Dollars Raised by the Company by Issuing the New Equity $1,000,000 (100,000 new shares times $10 per share = $1,000,000) Suppose Wow Co. is a brand new company and issues 100,000 shares of common stock (‘equity’) at a price of $10 per share. Also, the par value of each new share is $2. © 2014 Craig Ruff

28 Accounting Treatment: Common Stock$200,000 Additional Paid in Capital$800,000 Common Stock: $200,000 = $2 par share par value * 100,000 shares. Additional Paid in Capital: $1,000,000 in money raised less the $200,000. Suppose Wow Co. is a brand new company and issues 100,000 shares of common stock (‘equity’) at a price of $10 per share. Also, the par value of each new share is $2. © 2014 Craig Ruff

29 t=0 Start of Company Net Income Dividends Retained Earnings Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

30 t=0t=1 Start of Company End of Year 1 Net Income $1,000,000 Dividends $0 Retained Earnings $1,000,000 Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

31 t=0t=1t=2 Start of Company End of Year 1End of Year 2 Net Income $1,000,000$3,000,000 Dividends $0 Retained Earnings $1,000,000$4,000,000 Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

32 t=0t=1t=2t=3 Start of Company End of Year 1End of Year 2End of Year 3 Net Income $1,000,000$3,000,000$4,000,000 Dividends $0 $500,000 Retained Earnings $1,000,000$4,000,000$7,500,000 Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

33 t=0t=1t=2t=3t=4 Start of Company End of Year 1End of Year 2End of Year 3End of Year 4 Net Income $1,000,000$3,000,000$4,000,000-$2,000,000 Dividends $0 $500,000 Retained Earnings $1,000,000$4,000,000$7,500,000$5,000,000 Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

34 t=0t=1t=2t=3t=4t=5 Start of Company End of Year 1End of Year 2End of Year 3End of Year 4End of Year 5 Net Income $1,000,000$3,000,000$4,000,000-$2,000,000$1,000,000 Dividends $0 $500,000 $750,000 Retained Earnings $1,000,000$4,000,000$7,500,000$5,000,000$5,250,000 Next, suppose Wow Co. has the following net incomes and dividend distributions over the next few years… © 2014 Craig Ruff

35 t=0t=1t=2t=3t=4t=5 Start of Company End of Year 1End of Year 2End of Year 3End of Year 4End of Year 5 Net Income $1,000,000$3,000,000$4,000,000-$2,000,000$1,000,000 Dividends $0 $500,000 $750,000 Common Stock $200,000 Additional Paid in Capital $800,000 Retained Earnings $1,000,000$4,000,000$7,500,000$5,000,000$5,250,000 Finally, suppose that Wow Co. does not issue any more new stock or buy back any existing stock over the next few years… © 2014 Craig Ruff

36 t=0t=1t=2t=3t=4t=5 Start of Company End of Year 1End of Year 2End of Year 3End of Year 4End of Year 5 Net Income $1,000,000$3,000,000$4,000,000-$2,000,000$1,000,000 Dividends $0 $500,000 $750,000 Common Stock $200,000 Additional Paid in Capital $800,000 Retained Earnings $1,000,000$4,000,000$7,500,000$5,000,000$5,250,000 Total Book Value of Common Stock $1,000,000$2,000,000$5,000,000$8,500,000$6,000,000$6,250,000 Finally, suppose that Wow Co. does not issue any more new stock or buy back any existing stock over the next few years… © 2014 Craig Ruff

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