Simple Balance Sheet Example

Accounting statements in the United States are prepared according to what are called generally accepted accounting principles (GAAP), it is also make simple balance sheet example. GAAP include the conventions, rules and procedures that define how companies should maintain records, performa of balance sheet and prepare financial reports. In the United States, these rules and procedures are based on guidelines issued by the Financial Accounting Standards Board (FASB). The FASB is the U.S. accounting profession's rule making organization.

Internationally, the set of generally accepted accounting principles varies from one country to another. In some cases U.S. GAAP are different from another country's GAAP British GAAP, for example, differ substantially from U.S. GAAP. As a result, a company's financial statements can look quite different depending on which country's GAAP are used to prepare them. In any case, you cannot compare the information contained in the financial statements of two companies when the statements were prepared under different system of GAAP until you first adjust for the differences.

Even under U.S. GAAP, it is possible for accounting numbers to distort economic reality. One of the tasks facing a good manager is to use accounting information effectively. Managers must know what accounting information can and cannot be used for. This is a balancing act. They have to combine their knowledge of accounting with other sources of information to make sound business decisions.

The accounting material covered in this post is a review of material covered in basic accounting courses. Our focus in financial management is on how to use and interpret this information, rather than on operating an accounting system and generating reports.

Financial Statements

A company's published annual report includes, at a minimum, an income statement a balance sheet, a statement of cash flows and accompanying notes. We review these statements below, using a basic set of statements for OutBack SportWear, Inc. as an example.They are the "raw material" for a variety of techniques and procedures that managers and analysts use in financial statement analysis. But first, let's introduce some basic terms we will need.

The maturity of an asset is the end of its life. When a financial asset is created (issued), the length of its life is called its original maturity. The amount of time remaining until maturity is called the remaining maturity.

The liquidity of an asset expresses how quickly and easily it can be sold without loss of value. Cash is the mos liquid asset.

Market value is the price for which something could be bought or sold in a "reasonable" length of time. A reasonable length of time is defined in terms of the asset's liquidity. It might be several months or even a year for buildings and land, but only a few days for publicly traded stocks and bonds. Book value (net book value) is a net amount shown in the accounting statements.

Balance Sheet

The balance sheet reports the financial position of a company at a particular point in time. The balance sheet shows the assets of the company, which are the productive resources used in its operations. The balance sheet also shows the liabilities and stock holder's equity of the company, which are the total claims of creditors and owners against the assets.A typical balance sheet, that of OutBack SportWear, is shown in the following table. Note that the balance sheet identity is satisfied:

Assets = Liabilities + Stockholder's equity 

Assets and liabilities are both broken down into short term and long term parts. In accounting statements, current (short term) refers to a period of up to one year. Long term refers to more than one year. Current assets are expected to become cash within one year. Current liabilities mature or are expected to be paid off with cash within one year. A long term asset and a long term liability have remaining maturities of more than one year. Current assets and liabilities are usually arranged in approximate order of remaining maturity, from shortest to longest. This arrangement reflects the fact that, generally, the book values of the short remaining maturity assets and liabilities tend to be closer to their current market values than those that have long maturities. For example, the book value of receivables may be fairly close to their market value. In contrast, the current market value of net fixed assets can be very different from their book value.

The liabilities and stockholders equity (right hand) side of the balance sheet shows the company's choice of its capital structure, the proportions of debt versus equity financing and the mixture of debt maturities, short term versus long term.
The difference between current assets and current liabilities is the company's net working capital, often simply called working capital.

Working capital = Current assets - Current liabilities

Working capital provides a measure of the business's liquidity or its ability to meet its short term obligations as they come due.
Table 01.
OutBack SportWear, Inc. Annual Balance Sheet ($ millions) December 31

Simple Balance Sheet Example

Income Statement

The income statement reports the revenues, expenses and profit (or loss) for a company over a specific interval of time, typically a year or a quarter of a year. Net income, sometimes referred to as profit, is the difference between total revenue and total cost for the period. Table 02 shows the income statement for OutBack SportWear. In this income statement, the gross profit is the net sales minus the cost of goods sold. The cost of goods sold is the direct cost for the materials, labor and other expenses directly associated with the production of the goods or services sold by the company.
To compute the operating profit, subtract from gross profit (1) the indirect costs associated with selling, general and administrative expenses and (2) depreciation and amortization (which are noncash items). Earnings before interest and taxes (EBIT) equals operating profit plus nonoperating profit (such as investment income). Subtracting interest expense from EBIT givers pretax income of $44.0 million in 1997. Finally, subtracting income taxes yields net income, $25.9 million in 1997, up from $18.0 million in 1996.
If the company has preferred stock outstanding, preferred dividends paid are subtracted from net income to get net income available for common stock. After subtracting whatever common stock dividends the company paid, the remaining earnings are the current period's addition to retained earnings on the balance sheet.
Dividends per share and earnings per share (EPS)are given in the bottom part of the income statement. The company's common stockholders have a residual claim on the company's assets after all debts and preferred stock have been paid. The stockholders welfare, then, depends on the current and future profitability and dividends of the company. The pershare figures indicate how large the net income is relative to the number of common shares. With 9 million shares outstanding, OutBack shows $2.77 in EPS in 1997.
Corporations occasionally declare an extraordinary gain or loss in addition to income or loss from their normal operation. OutBack SportWear did not report any extraordinary income. If a corporation had an extraordinary gain or loss, the income statement would show net income before and after (that is , without and with) the extraordinary gain or loss. In addition, EPS would be reported before and after the extraordinary income. For valuation purposes, EPS before extraordinary  items (without taking them into account) is a more meaningful measure of the company's sustainable profit.
Finally, dividends per share divided by EPS gives the company's payout ratio. The payout ratio is the proportion of earnings that the company paid out to common shareholders as cash dividends. OutBack's 1997 payout ratio is about 18% (=0.50/2.77).

Statement of Cash Flows

The statement of cash flows indicates how the cash position of the company has changed during the period covered by the income statement. Thus, it complements the income statement and the balance sheet. Changes in a company's cash position can be the result of any of the company's many transactions.
The statement of cash flows breaks down the sources and uses of cash into three components. These are cash flows from (1) operating, (2) investing and (3) financing activities. The flows of funds between a company and its investors, creditors, workers, customers and other stakeholders serve as a fundamental starting point for the analysis of the company, its
Table 02.

Simple Balance Sheet Example

capital investment projects and corporate acquisitions, as well as the analysis underlying many other decisions.

Table 03 shows a typical statement of cash flows, that of OutBack SportWear. The sources and amounts of cash flows from operating activities, investing activities and financing activities are itemized.
Let's look more closely at the cash flow from operating activities. The net income is taken from OutBack's income statement (Table 02). To arrive at net income, various items are deducted from sales, including some that are noncash expenses. Depreciation is usually the largest of these items. Because these items are not cash flows, they must be added back to determine cash flow. Dividends are not subtracted from operating activities. Instead, they are a discretionary part of financing activities. The other items represent changes in several working capital accounts, which are part of operating activities. Decreases (increases) in asset (liability) accounts are positive cash flows (inflows). The opposites are negative cash flows (outflows). One short term liability, notes payable, is considered a financing activity and is not included in operating activities.
Investing activities cash flows include those connected with buying or selling long term assets, acquiring other companies and selling subsidiaries. OutBack used $59.5 million to purchase plant and equipment, which is an outflow (negative cash flow).
Table 03.

Simple Balance Sheet Example

Financing activities cash flows include those connected with selling or repurchasing common and preferred stock, issuing or retiring long term debt, issuing and repaying short term notes and paying dividends on common stock or preferred stock. For example, OutBack borrowed $33.0 million in notes payable, which was an inflow.
Net increase (decrease) in cash and equivalents is the sum of the cash flows from the three sections: 23.4 - 59.5 + 33.6 = $(2.5) million. This change is then added to the beginning cash balance of $12.0 million, leaving the ending cash balance of $9.5 million.
In many financial decisions, such as long term investments, we separate the investing, financing and operating cash flows. It is important to understand that such separations in the statement of cash flows are somewhat arbitrary, particularly in the case of the first part of the statement, which shows the cash flows from operating activities. For example, dividends are included with financing cash flows, whereas interest expense is treated as an operating cash flow.

Notes to the Financial Statements

The notes to the financial statements are an integral part of the statements. The notes disclose the significant accounting policies used to prepare the financial statements. They also provide additional detail concerning several of the items in the accounting statements. Table 04 lists subjects usually included in such notes.
Table 04.

Simple Balance Sheet Example

Published annual reports also include management's discussion of recent operating results. Management's discussion is included along with the financial statements. Usually there is also a letter to the stockholders, which appears at the front of the annual report. This letter and the management's discussion can help you interpret the accounting statements. They can also provide insights into management's philosophy and strategy that simply don't appear in the numerical sections of the annual report.
The notes to the financial statements and management's discussion contain a wealth of useful information and make simple balance sheet example. You cannot fully appreciate the information contained in a company's accounting statements unless you read the notes to the financial statement and the management's discussion.\