W. Kandinsky, Church in Marnau, 1910

Investment School

The Balance Sheet

Assets

Current Assets

Assets that a company has at its disposal that can be easily converted into cash within one operating cycle. Current assets are important because it is from current assets that a company funds its ongoing, day-to-day operations.

Cash and Equivalents

Assets that are money in the bank, literally cold, hard cash or something equivalent, like bearer bonds, money market funds

Short-Term Investments

These normally come into play when a company has so much cash on hand that it can afford to tie some of it up in bonds with durations of less than one year. This money cannot be immediately liquefied without some effort, but it does earn a higher return than cash by itself. It is cash and investments that give shares immediate value and could be distributed to shareholders with minimal effort.

Accounts Receivable (A/R)

The money that is currently owed to a company by its customers. The reason why the customers owe money is that the product has been delivered but has not been paid for yet. Companies routinely buy goods and services from other companies using credit.

You will see something called allowance for bad debt in parentheses beside the accounts receivable number.

Inventories

The components and finished products that a company has currently stockpiled to sell to customers. Companies that have inventories growing faster than revenues or that are unable to move their inventories fast enough are sometimes disasters waiting to happen.

Non-Trade Receivables

is money due from sources other than customer purchases. These can include tax refunds, interest income, or the sale of property or equipment.

Restricted Cash

money set aside for a specific purpose, generally spelled out in a contract. A company may not use restricted cash for business operations, therefore it is listed separately from Cash and Equivalents on a balance sheet.

Prepaid Assets

Expenditures that the company has already paid to its suppliers.

Noncurrent(Total) Assets

Property, Plant, Equipment (PPE or fixed assets)

Assets owned or controlled by a company and used to produce or distribute the company's products. PPE will generally appear on the balance sheet grouped together at original cost, minus net accumulated depreciation. Original cost less depreciation is used instead of current market value because usually a company does not intend to sell these assets, so their current worth is not a relevant figure. Also, current market value is somewhat subjective, while original cost is easily verifiable.

Depreciation

The write-off for the reduction in usefulness and value of a long-term tangible asset. It not only affects the asset's value as stated on the balance sheet; it also affects the amount of reported earnings on the income statement. There are generally two categories of depreciation:

• Straight-Line Depreciation is the method of recording write-offs in equal amounts during each year of the asset's estimated useful life.
• Accelerated Depreciation is the method of writing off the cost of a capital asset in which the largest deductions are taken in the early years of the asset's life. The goal here generally is to delay taxes to a future date so that cash savings from the deferral can be reinvested to earn additional income.

Leased Assets

Assets that the company pays for the use of for a portion of its useful economic life. Companies lease assets to maintain flexibility over PPE and to preserve capital. There are two kinds of leased assets:

• Operating Leases are generally short-term leases for which rental payments are made by the lessee and full ownership rights are kept by the lessor. Operating leases are not recorded on the balance sheet.
• Capital Leases are long-term leases that represent a purchase of the asset by the company because the company will control the asset for nearly all of its useful life. Accounting rules require that the leased asset and the present value of the lease payments be recorded on the lessee's balance sheet. Assets under lease will appear under PPE.

Intangible Assets

Assets that have value even though they cannot be seen, felt, jumped over, or swum in. Brand Name is often the most important to a company's long-term success of the intangible assets. Others include copyrights, patents, a mining claim, or goodwill.

Goodwill

Asset that arises from the purchase of one business by another at a price greater than book value (actual net worth). When a company acquires another and the purchase price of that business is higher than the net asset value of the acquired business, the difference is transferred into an asset called "goodwill" when the two consolidate.

Amortization

Write-off of an intangible asset over time. Similar to depreciation, amortization reflects the declining value of an asset over its useful life. Under GAAP, intangibles should be amortized over at least 5 years and not more than 40 years.

Long-Term Investments

Investments the company plans on holding for more than one year. There are three methods of accounting for investments:

• The Cost Method is for less than 20% ownership of another company. This would be similar to how you would account for your personal investments. Income (dividends, usually) are recorded on the balance sheet, and gains or losses are not recognized until the asset is sold.
• The Equity Method is for ownership of 20% to 50% of another company. The initial investment is recorded on the balance sheet to reflect the initial cost plus a share of the investment's retained earnings, less dividends.
• The Consolidation Method is for ownership of at least 50% of another company. This involves combining financial statements of the parent and its controlled subsidiaries so that the assets of the parent and its subsidiaries are reported together.

Liabilities

Current Liabilities

Current liabilities are the debts and obligations that a company must pay within one year. These are short-term debts that arise from the purchase of current assets and include the portion of long-term liabilities due within the next 12 months. Current liabilities are bills due and IOUs hanging over a company's head.

Accounts Payable

Current liabilities incurred in the normal course of business. It's the money owed to partners and suppliers, with payment due at a later date. If cash is used for a purchase, the purchase will not add to accounts payable.

Accrued Expenses

Debts that are incurred by a company, but for which payment has not yet been made. These are normally periodic expenses such as wages, interest, and taxes that have not yet come due. From the time the expenses are incurred until the date they are due, they accumulate on the balance sheet as accrued expenses.

Income Tax Payable

The tax a company accrues over the year that it has yet to pay. Corporations make payments on taxes throughout the year based on its estimated taxable income. Generally a company must make installments totaling 90% of estimated taxes due to avoid penalties. Income tax payable is the portion of taxes due but not yet paid.

Short-Term Notes Payable

Various kinds of current interest-bearing debt that are accompanied by specific borrowing terms. Most companies will list in a footnote to this item when this debt is due and what interest rate the company is paying.

Long-Term Debt Payable

The portion of noncurrent debt that will come due within the year.

NonCurrent Liabilities

Obligations that a company must pay beyond one year of the date on the balance sheet. Noncurrent liabilities are listed at their present value, meaning this is the amount that would be paid to settle the obligation. The exception is future interest payments that are not yet due.

Long-Term (Funded) Debt

Loans and notes with a maturity greater than one year.

Bonds Payable

A form of debt issued for a period of more than one year. When an investor buys bonds, he or she is lending the company money. The seller of the bond agrees to repay the principal amount of the loan at a specified time, plus interest. The interest rate, date of maturity (when the principal is returned to the lender), and interest payment schedule are all incorporated into the bond. Bonds may be backed by collateral or unsecured. Unsecured bonds are known as Debentures. Bonds can either come to maturity all at once or staggered over time. Those that mature in increments are known as Serial Bonds. Sometimes, due to changing market interest rates, bonds are sold at a discount or a premium to their principal value. These discounts and premiums will be listed just below the bonds payable listing on the balance sheet.

Obligations Under Capital Lease

Long-term leases that represent a purchase of the asset by the company because the company will control the asset for nearly all of its useful life. A lease qualifies as capital if any of the following is true:

• The lease payments will total 90% or more of the fair market value of the property.
• The ownership of leased property converts to the lessee at the conclusion of the lease.
• The lease contains an option to purchase the property.
• The term of the lease is equal to or greater than 75% of the estimated useful life of the property.

Accounting rules require that the leased asset and the present value of the lease payments be recorded on the lessee's balance sheet.

Deferred Tax Liability

Liability will originate when the current deduction under GAAP accounting is less than the deduction as determined by the IRS. The company will defer the difference, temporarily saving on its tax liability.

Pension Liability

company's promise to pay retirement benefits to employees. There are two types of pension plans:

• Defined Contribution Plans require the company to contribute a fixed dollar amount to the plan in the present, with several investment options available to the employee for those funds. Typical defined contribution plans are 401(k) and 403(b) plans. Since the obligation to these plans are paid in the present, they are not listed under noncurrent liabilities
• Defined Benefits Plan, the company takes on an obligation to pay the employee a set amount each year upon retirement. In order for the company to meet its pension obligations down the road, it must contribute now and invest that money in such a manner that it will meet the defined pension benefits. The company's pension liability is the difference between its current value and what it is obligated to pay out in benefits.

Mortagages Payable

Owner's Equity

Owners' stake in the company. If you look at a company from a balance sheet perspective, it belongs to two parties: its owners and its creditors. Therefore, when you subtract the creditors' equity (liabilities) from total assets, what's left over is owners' equity.

Preferred Stock

Ownership in a corporation and gives the holder a claim prior to the claim of common stockholders on earnings. In the event of liquidation, referred stockholders are paid off before common stockholders, so they get first dibs after liability holders are taken care of. Preferred stock generally pays a fixed dividend, which usually must be paid before dividends are paid on common stock. These dividends are also cumulative -- any missed dividends must be made up prior to paying dividends to common stockholders. These securities, which carry no voting rights, are priced on dividend yield and trade much like long-term corporate bonds. Some agreements carry an option that allows preferred stock to be exchanged for a set number of common shares. Companies will issue preferred stock to increase their equity and reduce financial leverage.

Common Stock

Shares that have no preference to dividends or any distribution of assets. Common stock normally carries voting rights and its holders are the residual owners of a corporation in that they have a claim to what remains after every other party has been paid. Common stock of mature companies often pays quarterly dividends.

Additional Paid-In Capital

Occurs when proceeds from issuing common stock exceed par value.

Treasury Stock

Shares that have been issued and then repurchased. Treasury stock is not considerd in paying dividends.voting, or calculating earnings per share. It may be reissued at some point or retired completely. Treasury stock is not an asset. Companies cannot create an asset by holding stock in itself. The amount of treasury stock held is recorded as a reduction in shareholders' equity.

Retained Earnings

Income that has been retained for reinvestment in the business rather than being paid in dividends to shareholders. Income that is retained can be used to acquire additional income-earning assets, resulting in greater future profits. Retained earnings represent the maximum amount that could be distributed to shareholders if the company wished to do so.

Appropriated Retained Earnings

Earnings that have been earmarked by the company as not available for dividend payment. Let's say a company decides to take on a major project and wants to reserve a portion of earnings for that project. It can limit the dividend by appropriating some of its retained earnings for other uses. Appropriated retained earnings may be unappropriated at any time.

Foreign Currency Translation Adjustments

Adjustments occur when assets and liabilities of foreign subsidiaries are translated into U.S. currency at end-of-period rates of exchange. Income, expense, and cash flows are translated at weighted-average rates of exchange. These adjustments are recorded on the balance sheet as a part of shareholders' equity.

Glossary

	Operational Cycle	The time that it takes to sell a product and collect cash from the sale. It can last anywhere from 60 to 180 days
	Allowance for bad debt	The money set aside to cover the potential for bad customers, based on the kind of receivables problems the company may or may not have had in the past.
	GAAP	Generally accepted accounting principles
	par value	An arbitrary amount assigned to stock, which has little meaning in the present day where securities regulations are much different from bygone years.
	Working Capital	Working capital is current assets less current liabilities.