ECONOMÍA DE MINERALES

BALANCE SHEET
Asieh Hekmat
Reference: Rick J. Makoujy, Jr., (2010) “How to Read a Balance Sheet”, McGraw-Hill
Companies
What is Balance sheet
The balance sheet (hoja de balancia) shows what a company’s assets are (what it
owns), what its liabilities are (what it owes), and what its equity is (what’s left over) at a
specific point in time.

ASSETS = LIABILITIES + EQUITY

The balance sheet, also called the statement of financial position, is the expanded
expression of the accounting equation.
 Principal components of a balance sheet
Another way to state the equation:
Uses of resources = Sources of resources

Liabilities and owners' equity are the sources

from which the firm has obtained its funds.

The listing of assets shows the way that the firm's

managers have put those funds to work.

The balance sheet is the cumulative result of the firm's past activities.
Principal components of a balance sheet
 Assets are things a company owns and are sometimes referred to as the resources of
the company. Simply stated, assets represent value of ownership that can be converted
into cash (although cash itself is also considered an asset). Current assets include
inventory, while fixed assets include such items as buildings and equipment.

 Liabilities are obligations of the company; they are amounts owed to creditors for a past
transaction and they usually have the word "payable" in their account title. Liabilities also
include amounts received in advance for future services.

 Owners' equity is the residual interest in the assets of an entity after deducting liabilities.
 Assets
Assets are simply things a company owns. A company might own cash, equipment,
trademarks, real estate, pending tax refunds, inventory, or marketable securities.

Assets are generally broken into two categories:

 short-term (or current) assets

 Long-term assets.

Companies don’t own people (their employees), but it might feel that way sometimes!
CURRENT ASSETS
Current assets are those things a company owns that are expected to be turned into (or
used as) cash within one year from the date they’re listed on the balance sheet.
Examples of current, or short-term, assets include cash, short-term investments, IOUs
from customers (accounts receivable), prepaid expenses, and inventory.

 However, care should be taken to include only the qualifying assets that are capable
of being liquidated at the fair price over the next one year period.
NONCURRENT ASSETS
Noncurrent, or long-term, assets are those things
a company owns that are not expected to be
converted into or used as cash within one year.
Noncurrent assets are generally utilized in the
operation of a business. Examples include
equipment, furniture and fixtures, real estate,
patents, trademarks, and long-term investments.
LIABILITIES
Liabilities are simply monies that a company owes. A business might owe money to the Internal
Revenue Service in the form of taxes, to employees in the form of accrued payroll, to vendors in the
form of accounts payable, or to banks for credit cards, mortgages, and other loans.

Liabilities show how much cash will be needed (beyond weekly operating
expenses) to pay obligations that come due within the next year (current
liabilities) and beyond (long-term liabilities).
CURRENT LIABILITIES
Recall that current assets are expected to be used as or converted into cash within one year.
Similarly, current liabilities are those obligations, which the company must pay within 12 months
from the date of the balance sheet on which the current liabilities are shown.

Examples of current liabilities are accounts payable, accrued expenses, customer deposits,
and that portion of long-term debt’s principal that is due within a year.

Most long-term debt loans have a fixed monthly payment for a

specified number of months, the cost of borrowing the money,
and the repayment of the loan.
LONG-TERM LIABILITIES
Just like long-term assets, which are not expected to be converted into or used as
cash within one year from their posting on a balance sheet, long-term liabilities are not
required to be paid for at least one year.

Examples of long-term liabilities include real estate

mortgages, equipment loans, bonds, or bank debt. Of course,
some or all of these obligations might be due in the
upcoming 12 months, depending on their maturity dates and
whether or not some of the principal might be required to be
paid in the short run.
EQUITY
 Equity is simply the difference

between assets and liabilities.

 Equity is also called “net worth.” It

represents the value that the

owners have in the business.

If one were to sell all of a company’s assets for their book value and use the proceeds to pay
off all of its liabilities, what would be left over for the owners?

NET WORTH or EQUITY: the value the owners have in the company.
 Anglo America has listed the following information in the
finance statement on 31 December 2018. Classify the
information in a balance sheet and calculate Equity.

Account $1000 Account $1000

Intangible assets 3087 Inventories 4466
Short term borrowings 600 Environmental rehabilitation trusts 303
Derivative financial assets 132 Medium and long term borrowings 8371
Current tax liabilities 581 Property, plant and equipment 30898
Financial asset investments 396 Cash and cash equivalents 6567
Trade and other payables 4734 Retirement benefit obligations 609
Deferred tax liabilities 3676 Derivative financial liabilities 613
Current tax assets 121 Trade and other receivables 2026
Assets June 30,2009 Dec. 31, 2008
Current Assets:
Cash and cash equivalents $ 202,565 $ 180,578
Accounts receivable, net 6,617,105 5,821,593
Weighted average number of
Inventories, net 10,169,120 10,540,769 shares and equivalent shares of
Other current assets 1,365,456 1,181, 097 common stock outstanding:
Total current assets 18,354,337 17,688,037 Basic: 2,775,902

Property, plant and equipment, net 10,125,682 10,575,982

Last Trade: 2.58
Other assets 1,698,968 1,724,172 Prev. close: 2.5789
Bid: 2.46*100
Total Assets $ 30,178,987 $ 29,988,191 Ask: 2.58*500

Liabilities &Equity
Total current liabilities $ 16,299,152 $ 16,222180
Long term debt, less current maturities 5,469,538 6,018,655
Stockholders' equity 8,369,044 7,734,600
Non-controlling interest 14,253 12,756
Total liabilities and Equity $ 30,178,987 $ 29,988,191
Stock trading activities
Liabilities:
$ 16,299,152
Assets: +
Weighted average number of shares:
$ 5,469,538
2,775,902
$30,178,986
Equity:
$ 8,369,044
8369044
Book value per share = = 3.014
2775902

If we really believe the numbers of the balance sheet, we think the fair price for
each share is 3.014. Looking at the finance table of the company tells us that
the last trade was 2.58.
Why are balance sheets important?
It's clear that balance sheets are critical documents because they keep business owners like
you informed about your company's financial standing.

Many business owners fail to recognize their companies are in trouble until it's too late. This is
because some business owners aren't examining their balance sheets. Typically, if the ratio of
your business's assets to liabilities is less than 1 to 1, your company is in danger of going
bankrupt, and you'll have to make some strategic moves to improve its financial health.

Balance sheets are also important because these documents let banks know if your business
qualifies for additional loans or credit. Balance sheets help current and potential investors better
understand where their funding will go and what they can expect to receive in the future.
Analyzing a Balance Sheet
The 4 important Finance ratios that we can define from a balance sheet are:
 Liquidity ratio
Tells how well a company can pay off its short term debts and meet unexpected
needs for cash.
 Profitability ratio
Tell how much of each dollar of sales, assets, and owner`s investment resulted in
net profit.
 Leverage ratio
Show how and to what degree a company has financed its assets
 Efficiency ratio
Indicate how effectively a company uses its resources to generate sales.
What is liquidity?
Liquidity is the capacity of a business to find the resources needed to meet its obligations in the
short-term.

For such reason, the liquidity on the Balance Sheet is measured by the presence of Current
Assets in excess of Current Liabilities or the relationship between current assets and current
liabilities.

The main liquidity ratios are:

• Current ratio
• Quick Ratio (Acid or Liquid Test)
• Absolute Ratio
 liquidity
 Current ratio
This ratio shows the relationship between the company’s current assets over its current
liabilities. It measures the short-term capability of a business to repay for its obligations:

𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒂𝒔𝒔𝒆𝒕𝒔
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒓𝒂𝒕𝒊𝒐 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

 Example: If a business has:

Cash = $15 million Marketable securities = $20 million Inventory = $25 million
Short-term Debt = $15 million Accounts Payables = $15 million Current Ratio=?

A rate of more than 1 suggests financial well-being for the company. There is no upper-end on what is “too much”, as this can
be very dependent on the industry, however, a very high current ratio may indicate that a company is leaving excess cash
unused rather than investing in growing its business.
 liquidity
 Quick Ratio (Acid or Liquid Test)
Current Assets are those converted in cash within one accounting cycle. Therefore, while
the current ratio tells us if an organization has enough resources to pay for its obligations within
one year or so, the Quick ratio or acid test is a more effective way to measure liquidity in the very
short-term. Indeed, the quick ratio formula is:

𝑳𝒊𝒒𝒖𝒊𝒅 𝑨𝒔𝒔𝒆𝒕𝒔
𝑸𝒖𝒊𝒄𝒌 𝑹𝒂𝒕𝒊𝒐 =
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔

Liquid assets are defined as Current Assets – (inventory + Pre-paid expenses).

Although inventory and pre-paid expenses are current assets, they are not always turned into cash
as quickly as anyone would think.

Although, a quick ratio of over 1, can generally be accepted, while below one is usually seen as undesirable since you will not be able
to pay very short-term obligations unless part of the inventory is sold and converted into cash.
liquidity
 Absolute Ratio
This is the third current ratio, less commonly used compared to current and quick ratio. If the
quick ratio is more stringent in comparison to the current ratio, the absolute ratio is the strictest
of the three. This is given by:

𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒 𝑎𝑠𝑠𝑒𝑡
𝐴𝑏𝑠𝑜𝑙𝑢𝑡𝑒 𝑟𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Liquid assets – Accounts receivable = Absolute Assets.

Generally, cash on hand and marketable securities are part of the absolute assets. The
purpose of the absolute ratio is to determine the liquidity of the business in the very short-term
(few days).
What is profitability?
Profitability is the ability of any business to produce “earnings.” The Financial Statement,
which tells us whether a company is making profits or not is the Income Statement (or Profit
and Loss Statement).

The main profitability ratios used in financial accounting are:

– Gross profit margin

– Operating profit margin

– Return on capital employed (ROCE)

– Return on equity (ROE)

Profitability
 Return on capital employed (ROCE)
This measure assesses whether the company is profitable enough, considering the capital
invested in the business.

Indeed, it tells for each dollar invested in the business, how much return is generated.

The ROCE is the relationship between Operating Profit, and Capital Employed, expressed in
percentage terms.

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑝𝑟𝑜𝑓𝑖𝑡
𝑅𝑂𝐶𝐸 = × 100
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

Capital Employed = Total Assets – Current Liabilities

Profitability
Return on capital employed (ROCE)

Example: Imagine, company XYZ operating profit for Year-Two is $100K, and the capital
invested in the business (your total assets – current liabilities) is $500K.

100𝐾
𝑅𝑂𝐶𝐸 = × 100 = 20%
500𝐾

Therefore, for every dollar invested in the business the company made 20 cents. The higher
the ROCE, the better it is for its stakeholders. Consequently, an increasing ROCE overtime is
a good sign.
Profitability
 Return on Equity (ROE)
This is the relationship between net income and shareholder equity or, the amount of revenue
generated by the shareholder’s investment in the organization. This is one of the most used ratios
in finance.

𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
𝑅𝑂𝐸 = × 100
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

Example: Imagine the net income of Company XYZ in Year-Two was $20K and you invested
$100K. Therefore the ROE is (20/100) x 100% = 20%.

It means that the shareholders are getting rewarded overtime for their risky investment. This
leads to more future investments by other shareholders and the appreciation of the stock.
What is leverage ratios
The leverage ratios also called solvency ratios is used to help to assess the short and long-term
capability of an organization to meet its obligations. In fact, while the liquidity ratios help us to
evaluate in the very short-term the health of a business, the leverage ratios have a broader
spectrum.

Be reminded that the assets can be acquired either through debt or equity. The relationship
between debt and equity tells us the capital structure of an organization.

When, the debt grows (and interest expenses grow exponentially) too much, this can be a real
problem. Consequently, the Leverage Ratios help us to answer questions such as: Is the company
using an optimal capital structure? If not, is debt or equity the problem? If the debt is the
problem, will the company be able to repay for its contracted debt through its earnings?
leverage ratios

The main Leverage ratios are:

 Debt to equity ratio

 Interest Coverage Ratio

 Debt to Assets ratio

leverage ratios
 Debt to equity ratio
This ratio explains how much more significant is the debt in comparison to equity. This ratio can be
expressed either as number or percentage. The formula to compute the debt to equity ratio is:

𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡 𝑡𝑜 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 =
𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟`𝑠 𝑒𝑞𝑢𝑖𝑡𝑦

The debt to equity ratio measures the level of risk of an organization. Indeed, too much debt
generates high-interest payments that slowly erode the earnings.

When things go right, and the market is favorable, companies can afford to have a higher level of
leverage. However, when economic scenarios change such companies find them in financial
distress. Indeed, as soon as the revenues slow down, they are not able to repay for their scheduled
interest payments. Therefore, those companies will have to restructure their debt or face bankruptcy
leverage ratios
 Interest Coverage Ratio
The interest coverage tells us if the earnings generated are enough to cover for the interest
expenses. The interest coverage formula is:

𝐸𝐵𝐼𝑇
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑐𝑜𝑣𝑒𝑟𝑎𝑔𝑒 𝑟𝑎𝑡𝑖𝑜 =
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐸𝑥𝑝𝑒𝑛𝑠𝑒

The EBIT (earnings before interest and taxes) has to be large enough to cover for the interest
expense. A low ratio means that the company has too much debt and earnings are not enough to
pay for its interest expense.

A high ratio means instead the company is safe. Keep in mind that being too safe can be
limiting as well. In fact, an organization that is not able to leverage on debt may miss many
opportunities or become the target of larger corporations.
leverage ratios
 Interest Coverage Ratio
Example: Imagine that your coffee shop at the end of the year generated $10K in net income. The Interest
expense is $120K and taxes $20K. How do we compute the interest coverage ratio?

1. EBIAT or earnings before interest after tax is 10 + 120 = 130.

2. Take the EBIAT and add back the tax expense. Therefore you will get the EBIT. The EBIT is 130 + 20 = 150.

3. The interest coverage ratio is: 150: 120 = 1.25 times.

This implies that the EBIT is 1.25 times the interest expense. Therefore the company generates just enough
operating earnings to cover for its interest. However, it is very close to the critical level of 1. Below one the
company is risky. Indeed, it may be short of liquidity and close to bankruptcy anytime soon.
leverage ratios
 Debt to Assets Ratio
This ratio explains how much debt was used in acquiring the company’s assets and it is
expressed either in number or percentage. The formula is:

𝑻𝒐𝒕𝒂𝒍 𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔
𝑫𝒆𝒃𝒕 𝒕𝒐 𝑨𝒔𝒔𝒆𝒕 𝑹𝒂𝒕𝒊𝒐 =
𝑻𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔

Example: Imagine your coffee shop shows on the balance sheet $200K of total liabilities and $50K of equity.
How do we compute the debt to asset ratio?
1. Compute the total assets: $200K of liabilities + $50K of equity = $250K.
2. Compute the debt to asset ratio: $200 of liabilities / $250 of total assets = 0.8.
This means that 80% of the company’s assets have been financed through debt. A ratio lower than 0.5 or 50%
indicates a fair level of risk. A ratio higher than 0.5 or 50% can determine a higher risk of the business. Of
course, this ratio needs to be assessed against the ratio from comparable companies.