Welcome to week three of the Husky Investment Tournament! The standings are looking tight with only $30,000 separating first from 10th place.
Continuing on with our analysis of the financial statements, we have moved on to the balance sheet. The balance sheet gives a snapshot in time of the company. It gives us information about what the company owns, what they owe, and what the shareholders have provided.
The fundamental formula of accounting comes from the balance sheet:
Assets = Liabilities + Shareholder’s Equity
An asset is something that can provide future economic value. Some typical assets you would find include cash, property, equipment, and inventory. They are all owned by the company and will provide future value. A liability, on the other hand, is something the company will eventually have to pay. Some common liabilities include accounts payable, salaries payable, bonds payable. The company may choose to wait to pay their bills, but eventually, they will have to pay. Lastly, the shareholder’s equity portion shows how much of the company has been funded by the shareholders, and the resulting claim they are entitled to.
Let’s compare two companies:
|Company A||Company B|
|1000 Assets||1000 Assets|
|500 Liabilities||900 Liabilities|
|500 Shareholder’s Equity||100 Shareholder’s Equity|
Isolating this information, what company would you invest in?
Company A would be a better choice. Of the $1,000 they have in assets, half is funded by liabilities and half by shareholders. That is a much better ratio than having 90 percent of assets funded by liabilities like Company B.
In this week’s video, Trevor Salata, current MTU business student and Applied Portfolio Management Program alumnus, explains the balance sheet and how investors can use it to gauge investment decisions.