Understanding the Balance Sheet

Published November 25, 2013 by Mayrbear's Lair

8-8 (1)

Making investments in a company’s stock is a significant event in an individual’s life because an uninformed decision can become quite costly. To make the most informed decisions, individuals should conduct extensive research to help them make choices they feel secure about. To achieve this, many people can look to a company’s annual report for more insight into their financial condition. Roth (2008) explains that a company’s financial statements contained within their annual report are a significant asset to help individuals who are looking to make a sound investment in a company’s stock. They help people make better assessments by learning about a company’s strategies, financial health, and even information about their behavioral and moral values (Roth, 2008).  For this blog post, we will address our fictitious friend Liz who is confused about the true state of the Target Corporation’s financial condition (See Exhibit A below). This is a brand she is considering investing in because of her emotional attachment to it. However, the figures her buddy Tom disclosed upon reviewing their balance sheet suggested that investing in Target was not a sound idea because of the substantial percentage amount (74%) they invested of their total assets as risky obligations. Tom’s percentage rate caused Liz confusion because her calculations arrived at a different figure which was lower and amounted to 65%.

images

To help Liz with her confusion, we must explain how Tom arrived at his position. First, let’s analyze how Liz calculated her figures. For example, at the end of their fiscal year in February, 2008, the Target Corporation had liabilities (including current and long-term) that rounded off to about $29 million, while their asset totals came to about $45 million. To help Liz better understand these debt structure figures, she looked to a common-size balance sheet formula to translate these numbers into percentages. By taking the $29 million liabilities figure and dividing it by the $45 million asset figures, Liz came up with 65% as amount of debt Target has accrued. Tom, however, arrived at a figure that was nearly 10% higher which confused Liz because her math equations incontrovertibly added up.

Calculating-Percentages

What Liz did not take into consideration in her calculations, however, were the company’s commitments and contingencies contained within the notes of the report.  Fraser and Ormiston (2010) suggest that even though the balance sheet may not reflect a dollar amount in this category, this disclosure is intended to draw attention to the information that is located in the notes of the financial statements. These notes are significant because they list the commitments of a company’s contractual obligations that may still have an adverse effect on their financial outlook. Because companies engage in complicated financial reporting procedures that include such things as product financing, sales of receivables with recourse, limited partnerships and joint-ventures, that are not required to be included on the balance sheets, they are however, provided in the notes (Fraser & Ormiston, 2010). These are complicated components that are difficult to comprehend but play an important role in painting a full picture of the company’s operations. In other words, there are other factors that are not reported on a company’s balance sheet with unpredictable outcomes that can have an effect on Target’s future liabilities. In other words, Liz also needed to include in her calculations the figures provided in the commitments and contingency notes as well. These notes revealed for instance, that Target also had further contractual obligations and operating leases that extended beyond the year 2008 which included lease payments of $1,721 million with options that could extend the terms of the lease. Their contractual obligation payments also consisted of interest rates and a $98 million commitment in legally binding lease payments for the planned openings of future facilities that were scheduled to occur in 2008 or later. Tom arrived at his additional 10% figure because he factored in the information of these provisions to his equations and Liz did not.

Exhibit A

Target Example

References:

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Roth, R. (2008). The writers guide to annual reports. Atlanta, GA: Booksurge.com.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: