Understanding Balance Sheets
Choco-Bloc Company makes chocolate for retail and takes custom orders. To understand a balance sheet better, let us take a look at the elements of their balance sheet.
Current Assets: These are assets that are cash or cash like. They provide liquidity. Cash is the most liquid of assets. The company’s current account, cash reserves form its current assets. Cash reserves could be in the form of savings account, bank certificates, short-term assets .If the need arises these assets can be spent immediately.
Accounts Receivable: These monies are due from customers. These are amounts due from customers as a result of sales made on credit. Usually these amounts are due within 30 to 60 days of the sale. This is why they are considered current. Some businesses have longer credit periods. Six to nine months are the credit period in seasonal products. While credit periods are pre-agreed on, they usually extend beyond the term. This needs to be factored in during cash flow planning.
Allowance for Bad Debts: In some cases companies do not get paid for their purchases. Sometimes customers go under, withhold or deduct payments for quality issues. A reserve is made for this. This reserve usually absorbs the cost of bad debt and does not affect day to day functioning. This reserve enables a write off to expense. This allows for the bad debt to become a valuation adjustment.
Inventory: This is a term used for material held by the company. In the case of Chocó-bloc it would be coca, milk solids and so on would be part of the raw material inventory. Finished Chocolate bars and other products would be the finished goods inventory. Some part of the inventory would not be raw material but not yet finished goods. This would be part of the work-in-progress inventory. In the case of Choco’-blocs resellers and distributors only the finished products that they receive would be their inventory.
Pre-paid Expenses: Premium payments made in advance form part of pre-paid expenses. Tax payments made in advance is another pre-paid expense.
Fixed Assets: Physical assets of the company such as the factory, equipment within it are its fixed assets. They are not ‘liquid’ in nature. In the sense that they will not be converted to cash anytime soon. Fixed assets also depreciate in value over time, especially in the case of equipment. The land cost itself will appreciate over time.
Other Assets: are all elements of assets that do not fall under fixed or current assets. Investments in other firms, which do not directly impact Choco’-blocs business, come under this category.
Current Liability: This falls under the Liabilities side of the Balance Sheet. These are debts that need to be paid off in the next twelve months. When payments are received, these debts are paid.
Accounts Payable: This is the amount due to suppliers and service providers. This element generally forms the biggest item in current liabilities.
Accrued Payroll: The money earned by employees but not yet paid to them comes under this heading.
Other Accrued Liabilities: Sometimes companies incur expenses which are not invoiced. But so that the expense may be recorded it is put under this title.
Notes Payable and Other Bank Debt: Loans from banks and others come under this heading. They are not clubbed under accounts payable, since the terms are usually quite different. For example banks usually have conditions such as that Chocó-bloc must furnish its financial statements annually. Choco’-bloc cannot take other lines of credit. In some cases the property is given as collateral to the bank. This does not happen with suppliers, which is why they are kept under another category.
Long Term Liabilities has the following liabilities listed under it.
Lease Contracts: Machinery at Choco’ Bloc was taken on a lease basis. A lease contract is drawn out. If it is on a rental contract no transfer of ownership is shown. If the lease is drawn out like a purchase contract the asset and liability are recorded on the lessees books as if it were a purchase.
Long –Term Debt: Some Capital expenditure requires loans with long tenures. These loans are paid over a few or many years and are treated as long term debt. The portion of payment payable for a given year is shown under current t Liabilities.
Loans from Stockholders: Company stakeholders sometimes put in money in a crunch and pull it out when the need is over. Sometimes this takes longer than expected and is therefore put under this title.
Retained Earnings: Choco’ Bloc recorded profits in some years of its operation and losses in some. Profits were added to retained earnings and losses deducted from it. Since it recorded overall profit, it has substantial retained earnings. This was paid out as dividends so as to not attract taxes. In a Corporation retained earnings are not taxed. The company may pay the owners cash dividends over time. These accumulated earnings are listed as retained earnings.
Earnings are also retained by the company to protect itself against buy outs, ensure working capital, protect itself against any mishaps or buy other companies. A negative in retained earnings mean an overall loss. This therefore is a good element to watch when you buy a stock.
The Balance sheet is undoubtedly one of the most important financial reports that speak of a company’s health.
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