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Sheet
The balance sheet provides information on what the company owns (its assets), what it
owes (its liabilities) and the value of the business to its stockholders (the shareholders'
equity) as of a specific date. It's called a balance sheet because the two sides balance
out. This makes sense: a company has to pay for all the things it has (assets) by either
borrowing money (liabilities) or getting it from shareholders (shareholders' equity).
Assets are economic resources that are expected to produce economic benefits
for their owner
Shareholders' equity is the value of a business to its owners after all of its
obligations have been met. This net worth belongs to the owners. Shareholders'
equity generally reflects the amount of capital the owners have invested, plus any
profits generated that were subsequently reinvested in the company.
The balance sheet must follow the following formula:
Each of the three segments of the balance sheet will have many accounts within it that
document the value of each segment. Accounts such as cash, inventory and property
are on the asset side of the balance sheet, while on the liability side there are accounts
such as accounts payable or long-term debt. The exact accounts on a balance sheet will
differ by company and by industry, as there is no one set template that accurately
accommodates the differences between varying types of businesses.
A balance sheet looks like this:
Source: http://www.edgar-online.com
Here are the entries you'll find on a balance sheet and what each one means. Total
Assets
Total assets on the balance sheet are composed of the following:
Current Assets - These are assets that may be converted into cash, sold or consumed
within a year or less. These usually include:
Cash - This is what the company has in cash in the bank. Cash is reported at its
market value at the reporting date in the respective currency in which the
financials are prepared. Different cash denominations are converted at the market
conversion rate.
Accounts receivable - This represents the money that is owed to the company
for the goods and services it has provided to customers on credit. Every business
has customers that will not pay for the products or services the company has
provided. Management must estimate which customers are unlikely to pay and
create an account calledallowance for doubtful accounts. Variations in this
account will impact the reported sales on the income statement. Accounts
receivable reported on the balance sheet are net of their realizable value
(reduced by allowance for doubtful accounts).
Inventory - This represents raw materials and items that are available for sale or
are in the process of being made ready for sale. These items can be valued
individually by several different means, including at cost or current market value,
and collectively by FIFO (first in, first out), LIFO (last in, first out) or average-cost
method. Inventory is valued at the lower of the cost or market price to preclude
overstating earnings and assets.
Prepaid expenses - These are payments that have been made for services that
the company expects to receive in the near future. Typical prepaid expenses
include rent, insurance premiums and taxes. These expenses are valued at their
original (or historical) cost.
Long-Term assets - These are assets that may not be converted into cash, sold or
consumed within a year or less. The heading "Long-Term Assets" is usually not
displayed on a company's consolidated balance sheet. However, all items that are not
included in current assets are considered long-term assets. These are:
Investments - These are investments that management does not expect to sell
within the year. These investments can include bonds, common stock, long-term
notes, investments in tangible fixed assets not currently used in operations (such
as land held for speculation) and investments set aside in special funds, such as
sinking funds, pension funds and plan-expansion funds. These long-term
investments are reported at their historical cost or market value on the balance
sheet.
Fixed assets - These are durable physical properties used in operations that
have a useful life longer than one year. This includes:
Buildings or Plants - These are buildings that the company uses for its
operations. These assets are depreciated and are reported at historical
cost less accumulated depreciation.
Land - The land owned by the company on which the company's buildings
or plants are sitting on. Land is valued at historical cost and is not
depreciable under U.S. GAAP.
Other assets - This is a special classification for unusual items that cannot be
included in one of the other asset categories. Examples include deferred charges
(long-term prepaid expenses), non-current receivables and advances to
subsidiaries.
Intangible assets - These are assets that lack physical substance but provide
economic rights and advantages: patents, franchises, copyrights, goodwill,
trademarks and organization costs. These assets have a high degree of
uncertainty in regard to whether future benefits will be realized. They are reported
at historical cost net of accumulated depreciation.
Total Liabilities
Liabilities have the same classifications as assets: current and long term.
Current liabilities - These are debts that are due to be paid within one year or the
operating cycle, whichever is longer. Such obligations will typically involve the use of
current assets, the creation of another current liability or the providing of some service.
Usually included in this section are:
Bank indebtedness - This amount is owed to the bank in the short term, such as
a bank line of credit.
Accounts payable - This amount is owed to suppliers for products and services
that are delivered but not paid for.
Wages payable (salaries), rent, tax and utilities - This amount is payable to
employees, landlords, government and others.
Notes payable (short-term loans) - This is an amount that the company owes to
a creditor, and it usually carries an interest expense.
Dividends payable - This occurs as a company declares a dividend but has not
yet paid it out to its owners.
Current portion of long-term debt - The currently maturing portion of the longterm debt is classified as a current liability. Theoretically, any related premium or
discount should also be reclassified as a current liability.
Long-term debt (bonds payable) - This is long-term debt net of current portion.
Pension fund liability - This is a company's obligation to pay its past and current
employees' post-retirement benefits; they are expected to materialize when the
employees take their retirement for structures like a defined-benefit plan. This
amount is valued by actuaries and represents the estimated present value of
future pension expense, compared to the current value of the pension fund. The
pension fund liability represents the additional amount the company will have to
contribute to the current pension fund to meet future obligations.
Multi-Step
Single-Step Format
Format
Net Sales
Net Sales
Cost of Sales
Materials and Production
Gross Income*
Marketing and Administrative
Selling, General
Research and Development
and Administrative
Expenses(R&D)
Expenses (SG&A)
Operating
Other Income & Expenses
Income*
Other Income &
Pretax Income
Expenses
Pretax Income*
Taxes
Taxes
Net Income
Net Income (after
-tax)*
(Figures USD)
Net Sales
Cost of Sales
Gross Income
Operating Expenses (SG&A)
Operating Income
Other Income (Expense)
Extraordinary Gain (Loss)
Interest Expense
Net Profit Before Taxes (Pretax
Income)
Taxes
Net Income
2008
2009
1,500,000 2,000,000
(350,000) (375,000)
1,150,000 1,625,000
(235,000) (260,000)
915,000 1,365,000
40,000 60,000
(15,000)
(50,000) (50,000)
905,000 1,360,000
(300,000) (475,000)
605,000 885,000
Here are some of the different entries that may be found on the income statement and
what each one means.
Sales - These are defined as total sales (revenues) during the accounting period.
Remember these sales are net of returns, allowances and discounts.
Cost of Goods Sold (COGS) - These are all the direct costs that are related to
the product or rendered service sold and recorded during the accounting period.
(Reminder: matching principle.)
Operating expenses - These include all other expenses that are not included in
COGS but are related to the operation of the business during the specified
accounting period. This account is most commonly referred to as "SG&A" (sales
general and administrative) and includes expenses such as selling, marketing,
administrative salaries, sales salaries, maintenance, administrative office
expenses (rent, computers, accounting fees, legal fees), research and
development (R&D), depreciation and amortization, etc.
Other revenues & expenses - These are all non-operating expenses such as
interest earned on cash or interest paid on loans.
Income taxes - This account is a provision for income taxes for reporting
purposes.
Net income from continuing operations - This component takes into account
the impact of taxes from continuing operations.
Non-Recurring Items
Discontinued operations, extraordinary items and accounting changes are all reported as
separate items in the income statement. They are all reported net of taxes and below the
tax line, and are not included in income from continuing operations. In some cases,
earlier income statements and balance sheets have to be adjusted to reflect changes.
Extraordinary items - This component relates to items that are both unusual and
infrequent in nature. That means it is a one-time gain or loss that is not expected
to occur in the future. An example is environmental remediation.
Lease-breaking fees
Employee-separation costs
Lease-breaking fees
Extraordinary Items
Events that are both unusual and infrequent in nature are qualified as
extraordinary expenses.
Discontinued Operations
Sometimes management decides to dispose of certain business operations but either
has not yet done so or did it in the current year after it had generated income or losses.
To be accounted for as a discontinued operation, the business must be physically and
operationally distinct from the rest of the firm. Keep in mind these basic definitions:
Measurement date This is the date when the company develops a formal plan
for disposing.
Phase-out period This is the time between the measurement date and the
actual disposal date.
The income or loss from discontinued operations is reported separately, and past income
statements must be restated, separating the income or loss from discontinued
operations.
On the measurement date, the company will accrue any estimated loss during the
phase-out period and estimated loss on the sale of the disposal. Any expected gain on
the disposal cannot be reported until after the sale is completed (the same rule applies
to the sale of a portion of a business segment).
Accounting Changes
Accounting changes occur for two reasons:
1. As a result of a change in an accounting principle.
2. As a result of a change in an accounting estimate.
The most common form of a change in accounting principle is the switch from
the LIFO inventory accounting method to another method such FIFO or average cost
basis.
The most common form of a change in accounting estimates is a change in depreciation
method for new assets or change in depreciable lives/salvage values, which is
considered a change in accounting estimates and not a change in accounting principle.
Note that past income does not need to be restated from the LIFO inventory accounting
method to another method such FIFO or average cost basis.
In general, prior years' financial statements do not need to be restated unless it is a
change in:
Change to or from full-cost method (This is used in oil and gas exploration. The
successful-efforts method capitalizes only the costs associated with successful
activities while the full-cost method capitalizes all the costs associated with all
activities.)
Though these items are typically not included in the statement of cash flow,
they can be found as footnotes to the financial statements.
Tags:
Shares|
Insurability|
Embedded Value|
depreciation
Financial analysts employ several valuation ratios for analysing and identifying over- and undervalued
stocks. Most research reports concentrate on the application of such valuation ratios and say very
little about the rudiments.
It is important for small investors to understand the basics of such ratios as these can help them
analyse the stocks more effectively.
In the first part of the series on understanding financial ratios, we look at the EV/EBITDA ratio, which
is preferred by some analysts over the price to earnings or PE ratio.
HOW TO CALCULATE THE RATIO
This ratio has two components: EV and EBITDA. EV, or enterprise value, is calculated by adding the
market value of equity and debt, and subtracting the cash holding as shown in the firm's book of
accounts. It gives the cost of acquiring business, as the buyer needs to pay the market value of equity
or market capitalisation while purchasing the company. However, the cash with the firm acts as a
cushion for the buyer and needs to be deducted.
The value of debt must also be included while estimating the acquisition cost since the interest cost
on debt can affect the firm's future cash flow and the principal is repayable on maturity.
The other part of the metric is the EBITDA, which is also known as the operating profit. EBITDA is the
earning before interest cost, tax, depreciation and amortisation, and appears in the firm's income
statement. The other way of arriving at EBITDA is by adding depreciation, interest cost and tax to the
net earning.
Comparing the firm's performance based on net earning leads to a bias due to differences in
accounting policies and capital structures. This is because some firms may charge depreciation on an
accelerated basis, which leads to high depreciation costs in the initial years.
In addition, some firms have a high debt in their capital structure leading to high interest costs. Such
depreciation and interest costs ultimately depress the net earnings. EBITDA discards such difficulties
due to varying depreciation policies and debt-equity mix. This measure of earning is also sometimes
used as a proxy for cash flow as it adds the non-cash expenditure (depreciation).
HOW IT DIFFERS FROM PE RATIO
The PE ratio measures the money that investors are willing to pay for every rupee a company earns.
It is a metric used for valuing the firm's equity as it takes into account the residual earning available to
equity shareholders.
Though widely used, PE ratio has its limitations as it cannot be used for valuing lossmaking
companies and fails to overcome the distortions caused by different accounting policies and capital
structures.
The EV/EBITDA ratio is better as it values the worth of the entire company. PE ratio gives the equity
multiple, whereas EV/EBITDA gives the firm multiple. The latter is based on the notion of most
successful investors, who propose that equity investing is not just buying/selling shares, but
buying/selling the business.
WHAT THE RATIO MEANS
The division of EV by EBITDA gives a good measure of value. It estimates the number of years in
which the business will repay its acquisition cost to the buyer through its earnings. For example, if one
is interested in buying a firm at an EV of Rs 1,000 crore and its annual earning (EBITDA) is Rs 200
crore, the firm will repay its entire acquisition cost to the buyer in cash in just five years.
Generally, the lower the ratio, the better it is. The ratio helps determine the true earning potential of
the business. It is ideal for valuing telecommunication and cement & steel companies as these carry a
high debt in their balance sheets and have high gestation periods.
The ratio proves a great tool for valuing companies that are making losses at the net earning level, but
are profitable at the EBITDA level. However, the ratio is harder to calculate as it requires several
adjustments in the net income.
Also, EV value is not readily available and has to be derived from the firm's financial statements.
Estimating the true market value of debt is also not easy as it is influenced by changes in interest
rates.
EV/EBITDA T12
Deutsche Lufthansa AG
3.26
RWE AG
3.51
K+S AG
4.33
Continental AG
4.78
E.ON SE
4.80
Deutsche Telekom AG
5.85
ThyssenKrupp AG
6.27
HeidelbergCement AG
6.82
Volkswagen AG
6.93
LANXESS AG
7.25
7.26
Deutsche Post AG
8.19
Infineon Technologies AG
8.19
8.74
BASF SE
8.82
Bayer AG
8.97
Linde AG
9.10
Merck KGaA
9.12
10.33
Siemens AG
11.05
11.46
Adidas AG
11.85
Daimler AG
11.86
Deutsche Boerse AG
13.64
SAP AG
13.93
Beiersdorf AG
15.59
The cheap stocks are those companies, which are REALLY capitalintensive. Clearly, RWE and EON need to continuously reinvest into their
huge power stations or they will not be able to produce any electricity
soon. On the other hand, Deutsch Brse is basically a market making
software with some computers and a government license. Very few assets,
small depreciation.
So the difference between low EV/EBITDA and HIGH EV/EBITDA is not
necessarily cheapness but different levels of capital intensity
EV/EBIT
This is why many professionals prefer EV/EBIT to EV/EBITDA. EBIT
already deduces depreciation and should therefore be a better proxy
for Free cashflow than EBITDA.
Lets look at the Dax companies sorted by EV/EBIT:
EV/T12M EBIT
EV/EBITDA T12M
SDF GY Equity
5.7
4.3
CON GY Equity
7.5
4.8
EOAN GY Equity
7.5
4.8
RWE GY Equity
7.9
3.5
FRE GY Equity
11.2
8.7
HEI GY Equity
11.2
6.8
TKA GY Equity
11.3
6.3
DPW GY Equity
12.3
8.2
BAYN GY Equity
12.7
9.0
BAS GY Equity
13.0
8.8
FME GY Equity
13.4
10.3
HEN3 GY Equity
13.6
11.5
LXS GY Equity
13.6
7.3
BMW GY Equity
13.9
7.3
DTE GY Equity
14.3
5.8
DB1 GY Equity
15.8
13.6
VOW3 GY Equity
16.0
6.9
SIE GY Equity
16.2
11.0
LHA GY Equity
16.2
3.3
MRK GY Equity
16.6
9.1
LIN GY Equity
16.7
9.1
SAP GY Equity
17.0
13.9
BEI GY Equity
18.3
15.6
ADS GY Equity
18.6
11.9
DAI GY Equity
19.2
11.9
IFX GY Equity
22.5
8.2
avg
13.9
8.5
Swiss MArket Index trades at 16.7 x EBIT and 12.2 EBITDA significantly
higher than the German index. At least part of that is due to the much
lower tax rate in Switzerland and even lower interest rates.
So a comparison of peer companies across countries with very different
tax rates ind interest rates should not solely be based on EV/EBIT or
EV/EBITDA.
Other issues with EV/EBIT and EV/EBITDA financial companies
and financing business
EV measures usually dont work well with financial companies and also
companies which have a lot of financing business on their books.
Originally, EV is meant to capture real leverage, i.e. debt issued to pay
for machinery, inventory etc. Debt issued to fund for instance client
purchases is referred to as operating leverage. It is a little bit a grey
area. Clearly, one should prefer a company which sells only stuff against
cash than financing it for several years. The financial crisis in 2008 has
shown that such operating leverage quickly became strategic if the
roll over doesnt work. On the other hand, in normal times operating
leverage could be potentially adjusted against EV as you have extra
assets.
If one tries to compare financial companies vs. industrial companies
though, P/E is clearly more useful, as financial companies per definition
have much higher EVs than non-financial companies.
Price /Comprehensive income
This is a ratio which I use especially for financial companies.
Comprehensive income inlcudes all kind of value changes which are
booked directly against equity, such as changes in the value of pension
libailities, value changes of financial assets including hedges, currency
translations etc. Especially for financial companies, comprehensive
income is a pretty good leading indicator although it is rarely used in
my experience.
Summary:
In general, I would recommend to look at all Popular ratios in parallel,
because it gives a better multi dimensional view on a company. For