In the previous blog on corporate numbers, we had dived into the waters of corporate financial accounting and took a short swim towards the shallowest end with financial statements. In this blog, we would break down the details of each financial statement relative to their uses. My aim with this is to ensure that the reader is drawn into a universe that is totally misunderstood from the outside world.
Anyone who can read a regular label on a pack of cereal, or a cricket innings score can learn to read basic financial statements. If you can follow a recipe or apply for a loan, you can learn basic accounting. The basics are not difficult, and they are not rocket science.
What is most important is to have the basic knowledge to be able to understand what they contain and how the content herein can affect your decision as a manager or investor.
They are not necessarily always straightforward, but they provide a ‘numbered’ picture of what to do, when to do and how to do especially when they are studied in clusters, for example, historical financial statements.
We would start with the Statement of Financial Position – SOFP for short (IFRS nomenclature) or Balance Sheet (US GAAP). Please ensure to refer to the previous blog – The corporate numbers for a detailed explanation of IFRS and GAAP.
The SOFP provides information regarding three main parameters
- Shareholders Equity or Owners Equity.
Explanations regarding each are detailed below: Lets get on the finance train and make fun of it.
These are things that a company owns that have value. This typically means they can either be sold or used by the company to make products or provide services that can be sold. Assets include physical property, such as plants, trucks, equipment, and inventory. It also includes things that can’t be touched but nevertheless exist and have value, such as trademarks and patents. And cash itself is an asset. So are investments a company makes.
There are two types of Assets, these are
- Current Assets – Short term assets and depending on the context or purpose of use, can be easily converted to cash within a year.
Examples of this include – cash, inventory for a supermarket, accounts receivables, prepaid expense, raw materials, short-term investments.
- Noncurrent Assets – These are a company’s long-term assets and depending on the context or purpose, cannot be easily converted to cash within a financial year. Their costs are allocated over the number of years the assets are used and appear on a company’s SOFP.
Examples of this include – Good will, long-term investments, life insurance, intangible fixed assets (patents).
Simply put, these are debts. Expansively, they can be defined as what a company owes to others and are obliged to repay. This can include all kinds of obligations, like money borrowed from a bank to launch a new product, rent for use of a building, money owed to suppliers for materials, payroll a company owes to its employees, environmental cleanup costs, or taxes owed to the government. Liabilities also include obligations to provide goods or services to customers in the future.
There are primarily three types of liabilities but for the purpose of this blog, we would discuss two types. These are.
- Current Liabilities – These are debts or obligations due to creditors that a company is expected to pay within a year. They can be simplified as short-term debts.
Examples include – short-term debts, accounts payable, notes payable, dividends and company income tax
- Non-Current Liabilities – These are essentially long-term debts. They are not due to be paid to creditors within a year.
Examples include – Debentures, bonds payable, deferred tax liabilities, pension benefit obligations and long-term leases.
Shareholders’ equity or Owner’s equity
Sometimes called capital or net worth. It is the money that would be left if a company sold all its assets and paid off all its liabilities. This leftover money belongs to the shareholders, or the owners, of the company.
As is in most cases, something tends to link everything together and in the case of accounting, these 3 parameters under the SOFP are joined together by an equation also known as the accounting equation and that is:
ASSETS = LIABILITIES + SHAREHOLDERS’/OWNERS EQUITY
A company’s assets must equal, or “balance,” the sum of its liabilities and shareholders’ equity.
This is where it starts to get interesting as it did for me, and I urge you the reader to not relent and follow me on this journey of the corporate numbers.
See you in part 3!