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MENTORING - Fundamentals - Company fundamentals - Balance Sheet risk -…
MENTORING - Fundamentals - Company fundamentals - Balance Sheet risk
For a company, growth is secondary
However, the primary thing is its survival. A company's survival is decided by how strong its balance sheet is. Without a strong balance sheet, a company's performance is a woolly thing.
We should pick up companies that have robust balance sheets.
What is a balance sheet?
A balance sheet is an account that collects all the data regarding stock accounts. This information begins when the company is set up and keeps on accumulating as the company grows.
A balance sheet has everything that the company possesses since its inception.
A balance sheet is always forward looking. It is not backward looking.
These are the reasons why a Balance Sheet is the sanctum sanctorum of a company.
A balance sheet has many types of classifications. They are based on capital. That means we will see different types of capital classifications.
A balance sheet is divided into three parts: (a) assets; (b) liabilities; (c) equity.
Equity is a liability of a company. The money has to be returned one day or other. Though that money comes at last for the equity risk takers. These people/equity stakeholders are called
inside capital providers
. They are the owners of the company. Equity is the capital provided by internal stakeholders.
Liabilities are the capital provided by outsiders. They can be interest bearing or non-interest bearing. Interest bearing liabilities are called debt, given usually by banks. The other liabilities can be non-interest bearing and they can be many sources for this.
Liabilities are the capital provided by outsider capital providers.
With the capital that the company gets, i.e., equity and debt, it buys fixed capital and does many other things. Basically it builds the left side of the balance sheet, i.e.,
assets
.
That is why Assets = Liabilities + Equity. So Equity = Assets - Liabilities. Capital of internal owners = Assets - capital of external owners.
So a balance sheet balances because assets = liabilities + equity.
The assets are used to generate revenue. But at a cost. That cost is called expenses. So a company is connected with assets, liabilities, equity, revenue, expenses and profits this way.
The resultant profit in the P&L is added back to equity. That is a company's equity base keeps on growing.
For a company to be internally strong, its capital employed should be robust. That is not enough. That capital should be employed in such a way that it generates a decent return every financial year. This is called return on capital employed.
There are three types of capital classifications. (1) based on the source of capital (
equity, debt
); (2) based on timeframe of deployment (long term capital (capital expenditure), short term capital (working capital)); (3) based on the usage and time period (current,within a year, and non current (beyond a year)).