Three weeks ago, I started a new series called " Learnin's From My MBA." The series is meant to take business concepts I've learned in my MBA program and present them to you, an audience of scientists with no business background.
The first part, entitled "The Annual Report," briefly summarized the different sections of an annual report and what they can tell you about a company. Last week, in the third part of the series, I looked at the first quantitative part of my analysis: the Income Statement. Together, we examined what each line item of a typical income statement means, and we discussed some of the basic information that can be gained about the company by analyzing it.
This is the fourth part of the Annual Report series. Here, we're going to take a very basic look at the Balance Sheet, a second financial statement incorporated within any Annual Report that complements the information found in the income statement.
As usual, we'll be using a real-live company as an example--Alta Genetics, a small Canadian biotech firm. You can work along with this series by downloading their annual report in PDF format.
The Balance Sheet
The balance sheet gives an outline of where the company is right now in terms of what it owns and what it owes. It's as simple as that.
The first thing you'll notice about the balance sheet is that, unlike the income statement we did last week, the second line doesn't say "Years Ended December 31." Instead it says "December 31." Seems like nit-picking, but it's a huge difference, and it makes an even bigger difference in how you think about the statements. Where the income statement was a summary of the transactions that took place that year, the balance sheet looks at year-end alone: It's a snapshot of the company's position at one moment in time.
Like the income statement, the format is simple: a description of the line item on the left-hand side of the page, and a bunch of figures in two (or more) columns on the right-hand side. The first column is the figures for that year; the next couple of columns are the figures for years before that--a historical look back, for comparison. Alta Genetics's figures are two columns long, because the company is relatively new and only has 1 year of historical data to it in the form it exists in today.
Well, let's get down to it: a look at what each line means.
The first category of items in a balance sheet is always the company's assets. These are the tangible (and sometimes intangible) things the company owns or has some kind of title to. They are usually divided into "current" assets, or assets that are readily exchanged for cash, and "long-term" assets, like big buildings, which are hard to get rid of if you had to liquidate them quickly.
Let's take a look at the assets of Alta Genetics.
Under Current Assets, they've got five items: Cash, Accounts Receivable, Income Taxes Recoverable, Inventories, and Prepaid Expenses.
Cash is quite simply the amount of money the company has in the bank on 31 December 1997. You may think: Wow! These guys have $1.8 million in cash in the bank! They're doing pretty good! But remember, it's just what they have that day--they could have a payroll of $3 million due at the end of the week, which would make their financial situation really bad instead of really good. So the amount of cash you've got in the bank doesn't necessarily mean anything unless it's looked at in conjunction with everything else on the books.
Accounts receivable is the money the company's owed for work they did but haven't been paid for yet. Let's say you've got a small company that makes transgenic mice. A client asked you for a specific mouse, you've shipped it, and "their check is in the mail." The amount of that check would be added to your accounts receivable.
Accounts receivable have to be taken in context with the amount of sales you made to figure out how much they're really worth. If that guy you sold the transgenic mouse to 5 years ago still says "the check is in the mail," it'd be ridiculous to still have it in your accounts receivable, right? Well, you can get a good idea of how old these receivables are, on average, by comparing the figure in the accounts receivable line to the Revenue line from the Income Statement. Alta Genetics has $12.6 million in accounts receivable, on $50 million in sales this year, so, on average, their accounts receivable are about a quarter of their revenue (12.6/50). This makes their average account receivable about 3 months old.
Income Taxes Recoverable
This is money that you can get back from the government either for taxes that you overpaid last year or that you get because you lost money last year. It depends on the situation. In any case, the Income Taxes Recoverable are considered cash, as it's money recoverable from the government. It's rare (as you might imagine) to see income taxes recoverable being a significant part of a company's balance sheet or a significant portion of a company's assets.
This is what you have that you can sell soon. Back to the transgenic mouse company example, your inventories would be your stocks of mice. They'd be shown here not at the price you're planning on selling them for but the price you paid for them.
These are items such as a heating bill that you paid for a special, 5-year fixed rate, and you're only in year 3. It can also be a long-term advertising contract, where you've paid for your ads in Science for 1998 and it's only 1997, or the cost of that stationery in your closet. It's stuff that you're going to expense out soon, but you still own.
Long-term assets are assets that aren't readily convertible into cash. In Alta Genetics's case, they include six items: a loan receivable, development inventory, production livestock, investment tax credits, capital assets, and other assets.
A loan receivable is money the company lent someone, usually a business partner. This amount is owed the company, but the company's not getting it anytime soon.
Typically, inventory is a current asset. However, here, they have inventory that's not easily liquidated that they've decided to put under "long-term inventory." In our transgenic mouse analogy, this inventory would be the reagents you need in order to make transgenic mice rather than the mice themselves.
Because Alta makes animal products, the livestock they have to make the products is inventory, of sorts, but needs to be a separate line item. It's just so big that it deserves its own line.
Investment Tax Credits
Investment tax credits are a Canadian phenomenon--the Canadian federal or provincial government gives tax credits (or cash back from taxes) to companies that perform biotech research. Because Alta is entitled to these each year, they're an asset. Because they can't be sold, or used this year, they're a long-term asset.
The term capital assets usually refers to buildings, land, and "hard" assets of this nature.
You guessed it--this line item is for anything you've got that doesn't really fit anywhere else. You usually describe most of it in the notes that accompany the annual report, and it's not all that common to have as much "other assets" as Alta has here, but I guess a biotech company has a lot of stuff they're not sure how to categorize in traditional ways.
Well, that's it for what the company owns. The total, at the bottom, is, in the case of Alta Genetics, $65.8 million. This doesn't mean that, if they had a giant garage sale tomorrow, they could get $65.8 million, just that their "book value," or the value of what they have, either at the price they paid for it or something close to that, is about $65 million.
Liabilities, like assets, are subcategorized into current liabilities and long-term liabilities, or liabilities the company doesn't need to pay off this year or anytime soon. Current liabilities include bank indebtedness, accounts payable, income tax payable, and the current portion of the long-term debt.
This is the cash you owe the bank that's payable right away. Usually this is an operating credit line of some kind. Remember that any long-term loan from the bank would be in long-term debt, not here.
Accounts payable are, quite simply, what you owe your suppliers. They're kind of the opposite of accounts receivable: They're the bills you got in the mail but haven't paid yet.
Income Tax Payable
Again, this is another bill you got but haven't paid yet, but this time it's from the taxperson.
Current Portion of Long-Term Debt
This is the portion of your long-term debt that's due in the next year. It's kind of like a mortgage: If you've got a 25-year mortgage for $100,000, and $10,000 is due this coming year (part interest, part capital), you'd put $10,000 here and $90,000 under long-term debt.
Long-term liabilities include long-term debt, deferred income taxes, deferred foreign exchange gain (loss), and preferred shares.
The portion of your mortgage (or your student loan, etc.) that's not due in the next year.
Deferred Income Taxes
These are income taxes that are due, but you've made an agreement with Revenue Canada not to pay for a while. I wish I could do this as an individual!
Deferred Foreign Exchange Gain (Loss)
This company has a whole bunch of stuff in the United States, or they've got customers in the U.S., and they make their products in Canada. Either way, they've got some cash, or something, in a foreign currency, and it's represented here in Canadian dollars. So the fluctuation of the Canadian dollar to the foreign currency in which they have their assets is represented (or counteracted) here.
Preferred shares are kind of like debt. They're shares in your company that you've sold to outside investors, but that promise those investors a fixed rate of return (say, 14% interest every year). So although these shareholders theoretically own a part of the company and should probably be in the "Shareholders' Equity" section of the balance sheet, they're put here, just because, on a practical level, the shares look so much like debt to the company.
The difference, in theory, between the amount of stuff the company has and the amount it owes is called shareholders' equity. It's what the owners of the company get.
Shareholders' equity is usually divided into two headings: Share Capital and Retained Earnings. Retained earnings are simply the net earnings line from the income statement. The share capital line is the accumulated net earnings from year to year. But basically, the amount the owners own plus the amount they owe should, theoretically, be equal to the amount the company's stuff is worth. And, through miracles of accounting, it always is--the assets always equal the liabilities plus the owners' equity on a balance sheet.
What the owners are actually worth, of course, depends on the number of shares they have and how much they can sell those shares for on the public market, and not really on the owners' equity line of the balance sheet. And how the public market values a company is pretty complicated and doesn't really depend on the balance sheet all that much.
Well, now that we've gone through it, it really doesn't seem as complex, does it? Next week, we'll tackle the cash flow statement, completing the basic look at the figures in the annual report.