Thoughts about the balance sheet
This section covers everything related to the balance sheet and cash flow.
Some initial thoughts...
For a long time, I was purely looking at the balance sheet as it is stated. Assets, liabilities, equity. But what I didn’t know was that there are two ways to perform a meaningful balance sheet analysis. First, the traditional balance sheet. And second, the net asset structure.
Did you know there are two ways to perform a meaningful balance sheet analysis?
Let’s look at these two ways without getting into too many details. In this article, I illustrate the different options which form the basis for any subsequent analyses.
The balance sheet as illustrated in the screenshot shows the sources and uses of funds. Equity and liabilities are typically the sources of the funds (where does the money come from?) while assets show the uses of the funds (how do I use the money?).
Balance sheet created by the author
The net asset structure, as illustrated below, allows for a functional view, i.e. balance sheet items are clustered by type, most prominently working capital and net debt being adjusted/deducted from the enterprise value. Therefore, these items are often part of the contract (SPA — share purchase agreement).
In addition, the net asset structure also shows transparently which functional groups impact the company’s book value of equity to which extent.
Net assets structure created by the author
Note that assets are shown with a positive sign and liabilities with a negative sign.
How to transfer balance sheet items into net assets?
This depends on the level of granularity and is done, ideally, on an account level, i.e. each account is allocated to a functional group. If no detailed data is available, then it is also fine to indicate the net asset structure by allocating the different balance sheet items to the functional groups, as done in the example above.
- The balance sheet presents sources and uses of funds
- The net asset format shows a functional balance sheet and is in line with many purchase price agreements
There are two ways of analyzing a balance sheet, either by looking at the sources and uses of funds or by looking at functional groups. When you analyze a company or want to prepare a business plan, oftentimes the net asset structure is more straightforward, as it allows for clustering the items based on the different functions. In turn, if you want to stick as much as possible to the annual report, then the balance sheet view is completely fine.
Stay tuned, more to come...