You’ve figured out how to read an income statement, and have taken your first steps towards learning how to determine whether a company is worth investing in or not.
So… What’s next?
In this second part of the series of ‘How To Analyse A Stock‘, we’ll show you how to read a balance sheet. Another useful skill which should help you decide if you should invest in a company or not.
Disclaimer: we’re not experts but we just want to share the little that we know in hopes that it’ll help you to take the first steps in your investing journey and maybe even spark conversation in our Seedly Q&A!
An Analysis Of Seedly Chicken Rice Limited
For this exercise, I’ll continue using a fictitious chicken rice company, Seedly Chicken Rice Limited – that has been in the chicken rice business for the past 10 years – to explain the basics of how to evaluate a company in simple, bite-sized terms.
We’ve covered the company’s Income Statement previously. So now, let’s look at the company’s Balance Sheet.
Why Look At The Company’s Balance Sheet?
The Balance Sheet, or the Statement of Financial Position, is a statement showing the Assets, Liabilities, and Equity of the company. Basically, it tells you what the company owns and owes.
Here’s what Seedly Chicken Rice Limited’s Balance Sheet looks like:
* Note that these figures are for illustration purposes only.
Let us look at the definitions of some of the line items listed above.
An asset, by definition, is a resource with economic value that will provide a future benefit.
Current And Non-Current Assets
Assets can be classified into Current Assets and Non-Current Assets.
Current Assets are shorter-term assets, while Non-Current Assets are longer-term in nature. A benchmark for short-term will be assets which you hold for up to one year.
Some Current Assets include:
- prepaid insurance
Take, for example, Seedly Chicken Rice Limited does catering to companies for their events. The terms of payment are that these companies (debtors) can pay within 15 days of food delivery. These are called receivables, i.e amounts owed to them that they can expect to receive.
These include the materials, like chicken, rice, eggs, sauces and other cooking stuff that keep in their storeroom, they will constantly be using.
You usually pay insurance upfront and receive the “benefits” later. Here, Seedly Chicken Rice pays for insurance at the start for the whole year.
Some non-current assets include longer-term assets, like your Plant, Property Equipment (PPE) / Fixed Assets.
Fixed Assets include the kitchen equipment and other fixed assets, like their stoves, cooking equipment and other miscellaneous equipment. These items are usually carried at net book value on the balance sheet.
Net Book Value = Cost – Accumulated Depreciation
*Accumulated depreciation is the total depreciation amount since the start of acquiring the equipment until balance sheet date.
Seedly Chicken Rice Limited is a famous brand that is known all over Singapore. The Intangible Asset here will be their goodwill. Goodwill is their established reputation of serving delicious chicken rice, this is an ‘asset’ that brings value to Seedly Chicken Rice Limited, although they cannot physically touch it.
A liability is a company’s financial obligation Similarly like assets, liabilities are categorised into Current and Non-Current as well.
Take note that some Current Liabilities include Payables.
Every two weeks, Seedly Chicken Rice will preorder the materials they need for their cooking in advance. (Eggs, rice, sauce, etc… except for the chicken of course. They pride themselves on the freshness of their chickens.) The payment terms with their suppliers are 15 days after the delivery of the goods. These are called Payables, i.e amounts they owe to other parties.
Wages Payable refers to the wages that a company’s employees have earned, but have not yet been paid as of the Balance Sheet’s date. Here, we take it as they pay the employees at the end of the month. So as of 31 December 2018, they owe their employees one month’s worth of wages.
Non-current liabilities are those with a term of more than a year in nature.
Long Term Borrowings
When Seedly Chicken Rice Limited opened their new stall, they borrowed funds from the bank to do so. This loan is repayable within 5 years’ time. This is their Long Term Borrowings.
Let’s assume that Seedly Chicken Rice Limited is a very successful company and is publicly traded.
Their shares will form the Share Capital. Share Capital is the financing the company gets by issuing shares.
Share Capital = Share Price x Number of Shares Issued
*Usually a company would not be listed (publicly traded) with such small share capital, Figures are meant for illustration purposes only.
Think of it like the overall balance you have in your bank account. Every month after your income and expenses, whatever is left is your savings.
Similarly, a company’s Retained Earnings is the accumulated earnings of Seedly Chicken Rice after subtracting dividends that are paid out to investors.
1) Assets = 2) Liabilities + 3) Equity
The reason a Balance Sheet is named as such is because a company’s Assets must equate its Liabilities + Equity. Both sides must be balanced in order for the above statement to hold true.
Whenever a company expands its business and opens new stores, you will see that its Balance Sheet grows.
This is natural because their assets, liabilities and equity will increase when they purchase new equipment, have higher accounts receivables, incur more accounts payables, borrow more and increase their retained earnings.
That being said, whenever a company undergoes expansion and you see that its Balance Sheet grows… This is generally a good sign because it means that the company is profitable! I mean, no company is going to expand if they can’t even make money right?
This also means that there are good prospects for this company and you can proceed to consider investing in this company.
Next step, we’ll be looking at the Statement of Cash Flows.
Stay tuned for the next post!