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4 Balance Sheet Problems and Prevention Strategies for Business Owners

As a business owner, you’re going to run into a few accounting mistakes from time to time. Some of the biggest blunders you can make involve your business balance sheet. If you want to avoid balance sheet problems, learn about the most common errors you can make on your balance sheet and how to avoid them.

What is a balance sheet?

Before we can dive into balance sheet mistakes, let’s briefly review what a balance sheet is.

A balance sheet is a financial statement that tracks your company’s progress. Your balance sheet is broken down into three parts:

• Assets (what you own)
• Liabilities (what you owe)
• Equity (money left over after expenses)

On your business balance sheet, your assets should equal your total liabilities and total equity. If they don’t, your balance sheet is unbalanced. If your balance sheet doesn’t balance it likely means that there is some kind of mistake.

Keep this formula in mind for your balance sheet:

Assets = Liabilities + Equity

Your balance sheet is the best indicator of your business’s current and future health. If your balance sheet is chock-full of mistakes, you won’t have an accurate snapshot of your business’s financial health.

4 Balance sheet problems

All balance sheet problems are avoidable—you just have to know what to watch out for. Here are four balance sheet boo-boos you should be on the lookout for in your business.

1. Omitting transactions

At some point, recording a transaction on your balance sheet might slip your mind. Omitting accounting transactions is a fairly common (and very fixable) mistake.

Forgetting to record a transaction throws off the rest of your balance sheet. You might forget to record things like:

• Other expenses

Omitting transactions can cause your balance sheet to present an inaccurate financial future. To prevent this balance sheet issue, set reminders to record transactions regularly (e.g., monthly) to avoid missing information.

2. Recording transactions incorrectly

One major mistake business owners make with their books is incorrectly recording transactions and inverting numbers, known as transposition errors.

An accounting transposition error is when you reverse the order of two numbers when recording a transaction. For example, you might flip-flop two numbers (e.g., 52 vs. 25).

You can make a transposition error while writing down two numbers or a sequence of numbers on your balance sheet. This balance sheet error is super easy to make, and it can even happen to a seasoned business owner or bookkeeper.

Luckily, this error is just as easy to catch as it is to make. To avoid this balance sheet mistake, make sure you double-check any numbers you input on your balance sheet. Consider having another employee cross-check your transactions, too.

3. Forgetting to record inventory changes

Another common mistake that can plague your business balance sheet is forgetting to record inventory changes.

Sure, counting and changing inventory in your system is pretty straightforward. But some businesses tend to forget to tally up and update their inventory levels at the end of each period.

To remedy this, keep your inventory as up-to-date as possible. That way, you can avoid messing up your balance sheet and ensure your inventory is accurate in your records.

4. Not classifying data correctly

When you’re recording transactions on your balance sheet, you must correctly classify each transaction as an asset or liability. If you don’t accurately classify your transactions, you can wind up with a major balance sheet blunder.

As a brief recap, assets are physical or non-physical property that adds value to your business. Some examples of assets include your business’s computer, car, and trademarks. Here are a few types of asset accounts:

• Accounts receivable

Liabilities are current debts your business owes to other companies, organizations, employees, vendors, or government agencies. If you have more debts, you’ll have higher liabilities.

Your liabilities can be current (short-term) or noncurrent (long-term). Examples of liabilities include supplies, invoices, loans, and mortgages.

Types of liability accounts you may have include:

• Accrued expenses
• Unearned revenue
• Accounts payable

Clearly, assets and liabilities are not something you want to confuse on your business balance sheet.

Before recording a transaction on your balance sheet, make sure you’re classifying it correctly and recording it under the right liability or asset account. Double-check with an accountant or another professional if you’re unsure about how to classify a transaction.

How to prevent balance sheet mistakes

If you want to prevent common balance sheet errors, be on the lookout for red flags on your balance sheet. That way, you can catch errors before they snowball out of control.

Here are a few ways you can prevent balance sheet mistakes:

• Conduct a trial balance before creating your balance sheet
• Review balance sheet transactions regularly
• Pinpoint any problems ASAP
• Keep financial documents organized

When it comes to your balance sheet, the more organized you are, the better. The best thing your business can do is be as proactive as possible and keep detailed financial records for reference.

Mistakes are inevitable. But if you have a plan in place to track them down, you can avoid bigger balance sheet issues in the future.

Looking to avoid balance sheet mistakes? Patriot’s accounting software lets you streamline the way you record income and expenses. Say goodbye to accounting problems and try it out for yourself with a free trial!

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Top 10 ways to fix an unbalanced balance sheet

By Shaun Comley

Tuesday 22nd June 2021

Financial statements are a series of double entries. When we are setting up our Financial Statements, we must make sure we bring in both sides of the double entries to ensure our balance sheet balances. As Isaac Newton’s Third Law states ‘For every action there is an equal and opposite reaction’; to become a balance sheet king you must remember, ‘For every Debit, there is an equal and opposite Credit’

A balance sheet that doesn’t balance is the nemesis of many a modeller. There is nothing more infuriating than needing to deliver a model and just not being able to track down a balance sheet error, especially as the clock ticks away late into the night.

Don’t worry, I have felt the pain. The below are 10 practical steps that have been finely tuned after sleepless nights and 15 accounting exams. This article will hopefully speed up the process of debugging what is causing the imbalance and help avoid this issue reoccurring during your modelling career.

1. Make sure your Balance Sheet check is correct and clearly visible

Making the correct Balance Sheet check may seem obvious however, there are a few things we must ensure:

a) Net assets equals total equity

Starting from the most basic item, we must make sure that we have correctly linked our formula and that we are checking that net assets less total equity is equal to zero.

b) Appropriate rounding

Excel isn’t perfect, despite what we all may think, Excel only stores up to 15 significant figures. When we are building complex financial models, we will use all 15 significant figures. This can cause really small differences in our net asset and equity. However, when decision making, we may only care to the nearest dollar or cent. Using the ROUND function will ensure that our check has the level of tolerance that is material.

c) Check the absolute difference

Rather than checking each period we should create a global check of each period’s deltas. The most efficient way to do this is by summing all the deltas however, we could have an equal and opposite delta. If this occurred the global check would provide a false result. To avoid this error, always calculate the absolute difference.

d) Clearly visible throughout the model

Once we achieve a balance sheet that does balance, we need to make this check visible throughout the model. This should sit on the top ribbon of our spreadsheet, above any freeze panes you have on your calculation sheet. This will ensure that when we make any updates to model, if we cause an imbalance, we can diagnose it straight away. 

There are alternative methods to Balance Sheet checks. Many modellers will use a logic check to ensure that the delta between equity and net assets is below a certain tolerance number. This works effectively as a check; however, this method won’t help identify what is causing the imbalance.

2. Check that the correct signs are applied

Once we have created our check, our next step is to make sure income and assets are positive and costs and liabilities are negative. An extremely common mistake is missing a negative sign when incorporating items into financial statements. It is so easy to miss and can be hard to pick up. However, a run through of each line item on your Cashflow, Profit and Loss and Balance Sheet will help you identify these errors and is a super easy win.

3. Ensuring we have linked to the right time period

Two of Mazars’ guiding themes are “Keep it simple” and “Get it right”, this is extremely relevant when setting up financial statements.

To “ Keep it simple ”, Financial Statements should just be links to calculations within the workbook, we should not be performing calculations within them, otherwise there is a high potential for us to exclude this from another section of the statements.

To “ Get it right ”, we should ensure that we have consistent timing across all our sheets in the model. This will mean when we are linking on our financial statements, we are linking to the same column on our calculation sheet.

For example, if our calculation timeline starts in Column J, we are linking to Column J on our calculation sheets. By doing this we will avoid any misalignment error.

We can then do a simple check that we avoided any misalignment error for each of the first columns. A quick keyboard shortcut to help this is “Ctrl + `”, which will show formulas (“Ctrl + `” will switch it back to normal)

4. Check the consistency in formulae

A key pillar of almost every modelling best practice is consistency in formulae across the row. If we don’t have that consistency, it’s highly likely that your balance sheet doesn’t balance. A way to check formulae consistency is using Go to Special > Row differences. To do this highlight your financial statements formulae and use the shortcut “Ctrl + \”. This shortcut will highlight the cells in that range that have row inconsistencies. We then suggest colouring those cells in a bright colour to pick them out easily.

From here you then need to identify what is the correct formula to use. Don’t simply copy the formula on the left across, you may have corrected the formula midway across the sheet accidently (I’ve made this mistake before).

5. Check all sums

One of the most common errors when building financial models is missing rows within your summed range. When we insert a row above a sum, the range doesn’t update to include that new row.

A quick run through each of the Balance Sheet’s closing balances and your Financial Statement calculations to make sure you haven’t made this mistake. Check a couple throughout the row as another common error is to update the sum for the first column and not copying it across the row. This can also be done through checking the consistency in formulae as suggested in point 4.

It is also important to check the lines within your Cashflow and Profit and Loss to ensure that these are flowing down to your net cashflow and net profit after tax respectively. It’s very common to miss out a line reference in your Cashflow available for debt service (CFADS) or EBIT.

6. The delta in Balance Sheet checks

The above were the easy wins and hopefully you’ve been able to find your Balance Sheet differences. However, it becomes a little trickier from this point on, as its highly likely that you excluded something within your financial statements. So how do we find something that isn’t there?

This is where we create a second check, commonly known as “Balance sheet check 2”, which calculates the delta between two balance sheet checks.

This will allow us to see patterns in how our Balance Sheet imbalance changes,

which can be more informative than the value of the total imbalance. How then do we diagnose these:

a) Look for an exact match

Firstly, check to see if you have an exact match for difference within your financial statements. If you can find an exact match of the difference with one of the line items in your financial statements, it would suggest that you have only incorporated one side of the double entry

b) Consistently the same difference

This is highly likely to be a constant expense or revenue which is not escalated. An example of what is missing is straight line depreciation.

c) Slowly increasing/decreasing difference

When this is the case, we will need to look at things that are affected by inflation or interest rates. An increasing difference would suggest an item affected by inflation such as the revenue or expense, as these values would increase over time. A decreasing difference would suggest an item affected by interest rates, this is as over time the balance will decrease and thus the associated interest and payments. This is not necessarily always the case but should hopefully generate ideas of where to focus your efforts.

d) Jumps in the difference

This is a due to recurring items that don’t happen every period. Examples of this would be debt repayments or capex spend.

e) Unbalanced for a set period

Look at the time horizon that the balance sheet is imbalanced for, was a certain facility active during this period and no other period, this could be the cause of the difference.

Although this check won’t necessarily give you the exact reason for your balance sheet not balancing this will isolate your search. In addition, hopefully when you see the second check, you’ll start to recognise the numbers that you may be missing. You’ll be surprised how familiar numbers become from across the model. The more balance sheets you debug the more familiar you’ll become with this balance sheet check two.

7. Double and half the Balance Sheet check

This is a classic accounting trick; I was taught this while doing my accounting exams and financial audit. Within point 7 we have talked about identifying the difference using patterns, if we haven’t seen a pattern or a number, we are familiar with, by doubling or halving the difference this may allow us to find it. This will often help find items where we have put the incorrect sign and in which case have done two debits for example.

8. Work from right to left

While trying to debug what’s causing your imbalance, work from right to left. We need to identify the area where your Balance Sheet isn’t balancing and thus towards the end of your forecast there are likely to be less items active, for example debt facilities. This will allow us to refine our search, we can then work back to the start of the forecast, hopefully the items that aren’t active all the way to the end could be the causes of the imbalance.

9. Opening balance testing

When reforecasting of an existing Balance Sheet, it’s very easy to make mistakes and not properly incorporate all items. A way to check where these numbers are properly incorporated is changing the numbers and see what happens to your balance sheet check. When changing numbers in your opening Balance Sheet, the retained earnings should be the balancing number (net assets less share capital).

If you change an item on your opening Balance Sheet and your Balance Sheet delta changes, we know that there is an issue with this item. If there is no movement, it means that the appropriate debits and credits have been incorporated and we can move to the next Balance Sheet item.

10. Check changes period to period of Balance Sheet items

The last chance of resolving your issue, is to go through each item on the balance sheet from period to period (remember working right to left) and checking that the balance sheet movements are reflected in the profit and loss and or the cashflow. This can be quite a time-consuming activity but is a systematic way of ensuring all debits and credits have been correctly incorporated in the financial statements and should lead to you finding the imbalance.

Before your model is good to go

A test you should do before you’re finished is to run through all scenarios. Often in our base case financial model, certain functionality won’t be active for example, a Debt Service Reserve Account (DSRA). In our base case we might not expect to use the DSRA, but it may be required in some downside cases. An easy way to do this would be to include your checks within your scenario table to ensure you can detect balance sheet imbalances in non-active scenarios.

If your balance sheet still doesn’t balance after all these steps, you may benefit from attending one of our training courses. Our full course portfolio can be found here .

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How to Read & Understand a Balance Sheet

• 02 Apr 2020

When it comes to understanding a business, there are few financial statements more important than the balance sheet. The balance sheet offers critical insight into the health of a business that can be used by:

• Potential investors to decide whether to invest in a company
• Business owners to craft more effective organizational strategy
• Employees to adjust their processes to better reach shared organizational goals

Whether you’re a business owner, employee, or investor , understanding how to read and understand the information in a balance sheet is an essential financial accounting skill to have.

Here’s everything you need to know about understanding a balance sheet, including what it is, the information it contains, why it’s so important, and the underlying mechanics of how it works.

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What Is a Balance Sheet?

A balance sheet is a financial document designed to communicate exactly how much a company or organization is worth—its so-called “book value.” The balance sheet achieves this by listing out and tallying up all of a company’s assets, liabilities, and owners’ equity as of a particular date, also known as the “reporting date."

Typically, a balance sheet will be prepared and distributed on a quarterly or monthly basis, depending on the frequency of reporting as determined by law or company policy.

Check out our video on the balance sheet below, and subscribe to our YouTube channel for more explainer content!

The Purpose of the Balance Sheet

A balance sheet provides a summary of a business at a given point in time. It’s a snapshot of a company’s financial position, as broken down into assets, liabilities, and equity. Balance sheets serve two very different purposes depending on the audience reviewing them.

When a balance sheet is reviewed internally by a business leader, key stakeholder, or employee, it’s designed to give insight into whether a company is succeeding or failing. Based on this information, an internal audience can shift their policies and approach: doubling down on successes, correcting failures, and pivoting toward new opportunities.

When a balance sheet is reviewed externally by someone interested in a company, it’s designed to give insight into what resources are available to a business and how they were financed. Based on this information, potential investors can decide whether it would be wise to invest in a company. Similarly, it’s possible to leverage the information in a balance sheet to calculate important metrics, such as liquidity, profitability, and debt-to-equity ratio.

External auditors, on the other hand, might use a balance sheet to ensure a company is complying with any reporting laws it’s subject to.

It’s important to remember that a balance sheet communicates information as of a specific date. By its very nature, a balance sheet is always based upon past data. While investors and stakeholders may use a balance sheet to predict future performance, past performance is no guarantee of future results.

The Balance Sheet Equation

The information found in a balance sheet will most often be organized according to the following equation: Assets = Liabilities + Owners’ Equity .

While this equation is the most common formula for balance sheets, it isn’t the only way of organizing the information. Here are other equations you may encounter:

Owners’ Equity = Assets - Liabilities

Liabilities = Assets - Owners’ Equity

A balance sheet should always balance . Assets must always equal liabilities plus owners’ equity. Owners’ equity must always equal assets minus liabilities. Liabilities must always equal assets minus owners’ equity.

If a balance sheet doesn’t balance, it’s likely the document was prepared incorrectly. Typically, errors are due to incomplete or missing data, incorrectly entered transactions, errors in currency exchange rates or inventory levels, miscalculations of equity, or miscalculated depreciation or amortization.

Here’s a closer look at what's typically included in each of those categories of value: assets, liabilities, and owners’ equity.

An asset is defined as anything that is owned by a company and holds inherent, quantifiable value. A business could, if necessary, convert an asset into cash through a process known as liquidation. Assets are typically tallied as positives (+) in a balance sheet and broken down into two further categories: current assets and noncurrent assets.

Current assets typically include anything a company expects it will convert into cash within a year, such as:

• Cash and cash equivalents
• Prepaid expenses
• Marketable securities
• Accounts receivable

Noncurrent assets typically include long-term investments that aren’t expected to be converted into cash in the short term, such as:

• Intellectual property
• Equipment used to produce goods or perform services

Because companies invest in assets to fulfill their mission, you must develop an intuitive understanding of what they are. Without this knowledge, it can be challenging to understand the balance sheet and other financial documents that speak to a company’s health.

Related: Financial Statement Analysis: The Basics for Non-Accountants

2. Liabilities

A liability is the opposite of an asset. While an asset is something a company owns, a liability is something it owes . Liabilities are financial and legal obligations to pay an amount of money to a debtor, which is why they’re typically tallied as negatives (-) in a balance sheet.

Just as assets are categorized as current or noncurrent, liabilities are categorized as current liabilities or noncurrent liabilities.

Current liabilities typically refer to any liability due to the debtor within one year, which may include:

• Payroll expenses
• Rent payments
• Utility payments
• Debt financing
• Accounts payable
• Other accrued expenses

Noncurrent liabilities typically refer to any long-term obligations or debts which will not be due within one year, which might include:

• Bonds payable
• Provisions for pensions
• Deferred tax liabilities

Liabilities may also include an obligation to provide goods or services in the future.

3. Owners’ Equity

Owners’ equity , also known as shareholders' equity , typically refers to anything that belongs to the owners of a business after any liabilities are accounted for.

If you were to add up all of the resources a business owns (the assets) and subtract all of the claims from third parties (the liabilities), the residual leftover is the owners’ equity.

Owners’ equity typically includes two key elements. The first is money , which is contributed to the business in the form of an investment in exchange for some degree of ownership (typically represented by shares). The second is earnings that the company generates over time and retains.

A Balance Sheet Example

By looking at the sample balance sheet below, you can extract vital information about the health of the company being reported on.

For example, this balance sheet tells you:

• The reporting period ends November 30, 2018, and compares against a similar reporting period from the year prior
• The company’s assets total $60,173, including $37,232 in current assets and $22,941 in noncurrent assets
• The company’s liabilities total $16,338, including $14,010 in current liabilities and $2,328 in noncurrent liabilities
• The company retained $45,528 in earnings during the reporting period, slightly more than the same period a year prior

It's important to note that how a balance sheet is formatted differs depending on where an organization is based. The example above complies with International Financial Reporting Standards (IFRS), which companies outside the United States follow. In this balance sheet, accounts are listed from least liquid to most liquid (or how quickly they can be converted into cash).

If this balance sheet were from a US company, it would adhere to Generally Accepted Accounting Principles (GAAP), and the order of accounts would be reversed (most liquid to least liquid).

Related: GAAP vs. IFRS: What Are the Key Differences and Which Should You Use?

A Crucial Understanding

The information found in a company’s balance sheet is among some of the most important for a business leader, regulator, or potential investor to understand. Without this knowledge, it can be challenging to know whether a company is struggling or thriving, highlighting why learning how to read and understand a balance sheet is a crucial skill for anyone interested in business.

Do you want to take your career to the next level? Explore our online finance and accounting courses , which can teach you the key financial concepts you need to understand business performance and potential.

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What Is a Balance Sheet?

How balance sheets work, special considerations.

• Why Is It Important?
• Limitations
• Balance Sheet FAQs
• Corporate Finance
• Financial statements: Balance, income, cash flow, and equity

Balance Sheet: Explanation, Components, and Examples

What you need to know about these financial statements

The term balance sheet refers to a financial statement that reports a company's assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company's capital structure .

In short, the balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. Balance sheets can be used with other important financial statements to conduct fundamental analysis or calculate financial ratios.

Key Takeaways

• A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholder equity.
• The balance sheet is one of the three core financial statements that are used to evaluate a business.
• It provides a snapshot of a company's finances (what it owns and owes) as of the date of publication.
• The balance sheet adheres to an equation that equates assets with the sum of liabilities and shareholder equity.
• Fundamental analysts use balance sheets to calculate financial ratios.

Investopedia / Katie Kerpel

The balance sheet provides an overview of the state of a company's finances at a moment in time. It cannot give a sense of the trends playing out over a longer period on its own. For this reason, the balance sheet should be compared with those of previous periods.

Investors can get a sense of a company's financial well-being by using a number of ratios that can be derived from a balance sheet, including the debt-to-equity ratio and the acid-test ratio , along with many others. The income statement and statement of cash flows also provide valuable context for assessing a company's finances, as do any notes or addenda in an earnings report that might refer back to the balance sheet.

The balance sheet adheres to the following accounting equation, with assets on one side, and liabilities plus shareholder equity on the other, balance out:

Assets = Liabilities + Shareholders’ Equity \text{Assets} = \text{Liabilities} + \text{Shareholders' Equity} Assets = Liabilities + Shareholders’ Equity

This formula is intuitive. That's because a company has to pay for all the things it owns (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholder equity).

If a company takes out a five-year, $4,000 loan from a bank, its assets (specifically, the cash account) will increase by $4,000. Its liabilities (specifically, the long-term debt account ) will also increase by $4,000, balancing the two sides of the equation. If the company takes $8,000 from investors, its assets will increase by that amount, as will its shareholder equity. All revenues the company generates in excess of its expenses will go into the shareholder equity account. These revenues will be balanced on the assets side, appearing as cash, investments, inventory, or other assets.

Balance sheets should also be compared with those of other businesses in the same industry since different industries have unique approaches to financing.

As noted above, you can find information about assets, liabilities, and shareholder equity on a company's balance sheet. The assets should always equal the liabilities and shareholder equity. This means that the balance sheet should always balance , hence the name. If they don't balance, there may be some problems, including incorrect or misplaced data, inventory or exchange rate errors, or miscalculations.

Each category consists of several smaller accounts that break down the specifics of a company's finances. These accounts vary widely by industry, and the same terms can have different implications depending on the nature of the business. But there are a few common components that investors are likely to come across.

 Theresa Chiechi {Copyright} Investopedia, 2019.

Components of a Balance Sheet

Accounts within this segment are listed from top to bottom in order of their liquidity . This is the ease with which they can be converted into cash. They are divided into current assets, which can be converted to cash in one year or less; and non-current or long-term assets, which cannot.

Here is the general order of accounts within current assets:

• Cash and cash equivalents are the most liquid assets and can include Treasury bills and short-term certificates of deposit, as well as hard currency.
• Marketable securities are equity and debt securities for which there is a liquid market.
• Accounts receivable (AR) refer to money that customers owe the company. This may include an allowance for doubtful accounts as some customers may not pay what they owe.
• Inventory refers to any goods available for sale, valued at the lower of the cost or market price.
• Prepaid expenses represent the value that has already been paid for, such as insurance, advertising contracts, or rent.

Long-term assets include the following:

• Long-term investments are securities that will not or cannot be liquidated in the next year.
• Fixed assets include land, machinery, equipment, buildings, and other durable, generally capital-intensive assets.
• Intangible assets include non-physical (but still valuable) assets such as intellectual property and goodwill. These assets are generally only listed on the balance sheet if they are acquired, rather than developed in-house. Their value may thus be wildly understated (by not including a globally recognized logo, for example) or just as wildly overstated.

Liabilities

A liability is any money that a company owes to outside parties, from bills it has to pay to suppliers to interest on bonds issued to creditors to rent, utilities and salaries. Current liabilities are due within one year and are listed in order of their due date. Long-term liabilities, on the other hand, are due at any point after one year.

Current liabilities accounts might include:

• Current portion of long-term debt is the portion of a long-term debt due within the next 12 months. For example, if a company has a 10 years left on a loan to pay for its warehouse, 1 year is a current liability and 9 years is a long-term liability.
• Interest payable is accumulated interest owed, often due as part of a past-due obligation such as late remittance on property taxes.
• Wages payable is salaries, wages, and benefits to employees, often for the most recent pay period.
• Customer prepayments is money received by a customer before the service has been provided or product delivered. The company has an obligation to (a) provide that good or service or (b) return the customer's money.
• Dividends payable is dividends that have been authorized for payment but have not yet been issued.
• Earned and unearned premiums is similar to prepayments in that a company has received money upfront, has not yet executed on their portion of an agreement, and must return unearned cash if they fail to execute.
• Accounts payable is often the most common current liability. Accounts payable is debt obligations on invoices processed as part of the operation of a business that are often due within 30 days of receipt.

Long-term liabilities can include:

• Long-term debt includes any interest and principal on bonds issued
• Pension fund liability refers to the money a company is required to pay into its employees' retirement accounts
• Deferred tax liability is the amount of taxes that accrued but will not be paid for another year. Besides timing, this figure reconciles differences between requirements for financial reporting and the way tax is assessed, such as depreciation calculations.

Some liabilities are considered off the balance sheet, meaning they do not appear on the balance sheet.

Shareholder Equity

Shareholder equity is the money attributable to the owners of a business or its shareholders. It is also known as net assets since it is equivalent to the total assets of a company minus its liabilities or the debt it owes to non-shareholders.

Retained earnings are the net earnings a company either reinvests in the business or uses to pay off debt. The remaining amount is distributed to shareholders in the form of dividends.

Treasury stock is the stock a company has repurchased. It can be sold at a later date to raise cash or reserved to repel a hostile takeover .

Some companies issue preferred stock , which will be listed separately from common stock under this section. Preferred stock is assigned an arbitrary par value (as is common stock, in some cases) that has no bearing on the market value of the shares. The common stock and preferred stock accounts are calculated by multiplying the par value by the number of shares issued.

Additional paid-in capital or capital surplus represents the amount shareholders have invested in excess of the common or preferred stock accounts, which are based on par value rather than market price. Shareholder equity is not directly related to a company's market capitalization . The latter is based on the current price of a stock, while paid-in capital is the sum of the equity that has been purchased at any price.

Par value is often just a very small amount, such as $0.01.

Importance of a Balance Sheet

Regardless of the size of a company or industry in which it operates, there are many benefits of reading, analyzing, and understanding its balance sheet.

First, balance sheets help to determine risk. This financial statement lists everything a company owns and all of its debt. A company will be able to quickly assess whether it has borrowed too much money, whether the assets it owns are not liquid enough, or whether it has enough cash on hand to meet current demands.

Balance sheets are also used to secure capital. A company usually must provide a balance sheet to a lender in order to secure a business loan. A company must also usually provide a balance sheet to private investors when attempting to secure private equity funding. In both cases, the external party wants to assess the financial health of a company, the creditworthiness of the business, and whether the company will be able to repay its short-term debts.

Managers can opt to use financial ratios to measure the liquidity, profitability, solvency, and cadence (turnover) of a company using financial ratios, and some financial ratios need numbers taken from the balance sheet. When analyzed over time or comparatively against competing companies, managers can better understand ways to improve the financial health of a company.

Last, balance sheets can lure and retain talent. Employees usually prefer knowing their jobs are secure and that the company they are working for is in good health. For public companies that must disclose their balance sheet, this requirement gives employees a chance to review how much cash the company has on hand, whether the company is making smart decisions when managing debt, and whether they feel the company's financial health is in line with what they expect from their employer.

Limitations of a Balance Sheet

Although the balance sheet is an invaluable piece of information for investors and analysts, there are some drawbacks. Because it is static, many financial ratios draw on data included in both the balance sheet and the more dynamic income statement and statement of cash flows to paint a fuller picture of what's going on with a company's business. For this reason, a balance alone may not paint the full picture of a company's financial health.

A balance sheet is limited due its narrow scope of timing. The financial statement only captures the financial position of a company on a specific day. Looking at a single balance sheet by itself may make it difficult to extract whether a company is performing well. For example, imagine a company reports $1,000,000 of cash on hand at the end of the month. Without context, a comparative point, knowledge of its previous cash balance, and an understanding of industry operating demands, knowing how much cash on hand a company has yields limited value.

Different accounting systems and ways of dealing with depreciation and inventories will also change the figures posted to a balance sheet. Because of this, managers have some ability to game the numbers to look more favorable. Pay attention to the balance sheet's footnotes in order to determine which systems are being used in their accounting and to look out for red flags .

Last, a balance sheet is subject to several areas of professional judgement that may materially impact the report. For example, accounts receivable must be continually assessed for impairment and adjusted to reflect potential uncollectible accounts. Without knowing which receivables a company is likely to actually receive, a company must make estimates and reflect their best guess as part of the balance sheet.

Example of a Balance Sheet

The image below is an example of a comparative balance sheet of Apple, Inc . This balance sheet compares the financial position of the company as of September 2020 to the financial position of the company from the year prior.

In this example, Apple's total assets of $323.8 billion is segregated towards the top of the report. This asset section is broken into current assets and non-current assets, and each of these categories is broken into more specific accounts. A brief review of Apple's assets shows that their cash on hand decreased, yet their non-current assets increased.

This balance sheet also reports Apple's liabilities and equity, each with its own section in the lower half of the report. The liabilities section is broken out similarly as the assets section, with current liabilities and non-current liabilities reporting balances by account. The total shareholder's equity section reports common stock value, retained earnings, and accumulated other comprehensive income. Apple's total liabilities increased, total equity decreased, and the combination of the two reconcile to the company's total assets.

Why Is a Balance Sheet Important?

The balance sheet is an essential tool used by executives, investors, analysts, and regulators to understand the current financial health of a business. It is generally used alongside the two other types of financial statements: the income statement and the cash flow statement.

Balance sheets allow the user to get an at-a-glance view of the assets and liabilities of the company. The balance sheet can help users answer questions such as whether the company has a positive net worth, whether it has enough cash and short-term assets to cover its obligations, and whether the company is highly indebted relative to its peers.

What Is Included in the Balance Sheet?

The balance sheet includes information about a company’s assets and liabilities. Depending on the company, this might include short-term assets, such as cash and accounts receivable , or long-term assets such as property, plant, and equipment (PP&E). Likewise, its liabilities may include short-term obligations such as accounts payable and wages payable, or long-term liabilities such as bank loans and other debt obligations.

Who Prepares the Balance Sheet?

Depending on the company, different parties may be responsible for preparing the balance sheet. For small privately-held businesses , the balance sheet might be prepared by the owner or by a company bookkeeper. For mid-size private firms, they might be prepared internally and then looked over by an external accountant.

Public companies, on the other hand, are required to obtain external audits by public accountants, and must also ensure that their books are kept to a much higher standard. The balance sheets and other financial statements of these companies must be prepared in accordance with Generally Accepted Accounting Principles (GAAP) and must be filed regularly with the Securities and Exchange Commission (SEC).

What Are the Uses of a Balance Sheet?

A balance sheet explains the financial position of a company at a specific point in time. As opposed to an income statement which reports financial information over a period of time, a balance sheet is used to determine the health of a company on a specific day.

A bank statement is often used by parties outside of a company to gauge the company's health. Banks, lenders, and other institutions may calculate financial ratios off of the balance sheet balances to gauge how much risk a company carries, how liquid its assets are, and how likely the company will remain solvent.

A company can use its balance sheet to craft internal decisions, though the information presented is usually not as helpful as an income statement. A company may look at its balance sheet to measure risk, make sure it has enough cash on hand, and evaluate how it wants to raise more capital (through debt or equity).

What Is the Balance Sheet Formula?

A balance sheet is calculated by balancing a company's assets with its liabilities and equity. The formula is: total assets = total liabilities + total equity.

Total assets is calculated as the sum of all short-term, long-term, and other assets. Total liabilities is calculated as the sum of all short-term, long-term and other liabilities. Total equity is calculated as the sum of net income, retained earnings, owner contributions, and share of stock issued.

Harvard Business School Online. " How to Prepare a Balance Sheet: 5 Steps for Beginners ."

Cambridge Dictionary. " Par Value ."

U.S. Securities and Exchange Commission. " Standard Taxonomies ."

• Valuing a Company: Business Valuation Defined With 6 Methods 1 of 37
• What Is Valuation? 2 of 37
• Valuation Analysis: Meaning, Examples and Use Cases 3 of 37
• Financial Statements: List of Types and How to Read Them 4 of 37
• Balance Sheet: Explanation, Components, and Examples 5 of 37
• Cash Flow Statement: How to Read and Understand It 6 of 37
• 6 Basic Financial Ratios and What They Reveal 7 of 37
• 5 Must-Have Metrics for Value Investors 8 of 37
• Earnings Per Share (EPS): What It Means and How to Calculate It 9 of 37
• P/E Ratio Definition: Price-to-Earnings Ratio Formula and Examples 10 of 37
• Price-to-Book (PB) Ratio: Meaning, Formula, and Example 11 of 37
• Price/Earnings-to-Growth (PEG) Ratio: What It Is and the Formula 12 of 37
• Fundamental Analysis: Principles, Types, and How to Use It 13 of 37
• Absolute Value: Definition, Calculation Methods, Example 14 of 37
• Relative Valuation Model: Definition, Steps, and Types of Models 15 of 37
• Intrinsic Value of a Stock: What It Is and Formulas to Calculate It 16 of 37
• Intrinsic Value vs. Current Market Value: What's the Difference? 17 of 37
• The Comparables Approach to Equity Valuation 18 of 37
• The 4 Basic Elements of Stock Value 19 of 37
• How to Become Your Own Stock Analyst 20 of 37
• Due Diligence in 10 Easy Steps 21 of 37
• Determining the Value of a Preferred Stock 22 of 37
• Qualitative Analysis 23 of 37
• How to Choose the Best Stock Valuation Method 24 of 37
• Bottom-Up Investing: Definition, Example, Vs. Top-Down 25 of 37
• Financial Ratio Analysis: Definition, Types, Examples, and How to Use 26 of 37
• What Book Value Means to Investors 27 of 37
• Liquidation Value: Definition, What's Excluded, and Example 28 of 37
• Market Capitalization: What It Means for Investors 29 of 37
• Discounted Cash Flow (DCF) Explained With Formula and Examples 30 of 37
• Enterprise Value (EV) Formula and What It Means 31 of 37
• How to Use Enterprise Value to Compare Companies 32 of 37
• How to Analyze Corporate Profit Margins 33 of 37
• Return on Equity (ROE) Calculation and What It Means 34 of 37
• Decoding DuPont Analysis 35 of 37
• How to Value Private Companies 36 of 37
• Valuing Startup Ventures 37 of 37

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Module 4: Completing the Accounting Cycle

Practice: preparing financial statements, learning outcomes.

• Prepare an income statement
• Prepare a statement of owner’s equity
• Prepare a balance sheet
• Identify the three main components of the statement of cash flows
• Practice: Preparing Financial Statements. Authored by : Mike Zerrahn. Provided by : Lumen Learning. License : CC BY: Attribution

BUS202: Principles of Finance

Unit 2 Financial Statement Analysis Exercises

Complete these exercises and problems and then check your work.

The income statement captures all activity related to revenues and expenses over a particular time period. For instance, the quarterly income statement includes all revenue and expense items for that quarter. The beginning of the quarter is treated the same as the end of the quarter. The same applies for annual income statements. However, balance sheets represent a firm's assets, liabilities, and owners' equity at a particular point in time. The quarterly balance sheet only reflects the last day of that quarter and the annual balance sheet only reflects the last day of the year. As such, the balance sheet is more open to seasonality issues and short-term fluctuations. For instance, if the balance sheet is prepared 1 day prior to a large cash payment the cash account will appear artificially large. On the other hand, if it is prepared 1 day after the payment the cash account will appear artificially small.

The firm has $60 million in total liabilities.

A = L + OE $100M = L + $40M $60M = L

Depreciation is a noncash expense. While it lowers net income, the firm is not actually paying anything for depreciation so it has no impact on cash flows (ignoring taxes…when considering taxes, depreciation lowers net income but increases cash flows as less cash is paid in taxes). The cash flow impact of an asset purchase from a finance perspective occurs when the asset is purchased. Spreading the cost equally over the assets useful life ignores the time value of money and understates the true cost of the purchase. A few other issues that may create a difference between cash flows and earnings include (this is not a complete list) –

• Revenue recognition
• Inventory accounting method
• Prepaid expenses
• Accounts Payable/Receivable

While many people use ratio analysis, the primary parties interested are

• Competitors
• Stockholders (and potential stockholders)
• Long-Term Creditors
• Short-Term Creditors

When analyzing  Liquidity Ratios , the most interested parties are management and short-term creditors. Management needs to understand the firm's liquidity position in order to properly manage the firm. Short-term creditors typically do not care much about the long-term health of the firm, but only if they have enough liquid capital to meet the short-term obligations. Long-term creditors and stockholders would also be interested, but primarily only if the liquidity ratios were weak enough to damage the long-term health of the firm.

When analyzing  Asset Management Ratios , the most interested parties are management, competitors, and stockholders. Again, management must be interested in all the ratios as they must manage all aspects of the firms operations. Competitors are interested as a gauge of their own performance. If our competition has a total asset turnover of 2.50 and ours is only 1.95 we must understand what they are doing to outperform us in this measure. By identifying our weaknesses, we can address them. Stockholders have some interest in that often asset management ratios impact a firm's ability to generate profits and increase firm value. Long-term and short-term creditors are typically not significantly concerned with these measures as they do not share in any “extra” profits the company generates. As long as the firm is able to meet interest and principle obligations, debt holders are happy.

Management, long-term creditors, short-term creditors, and stockholders are all focused on  Debt Management Ratios . These ratios measure a firm's ability to meet their debt obligations, so creditors want to see these ratios strong in order to be confident of receiving their full interest and principle payments. Long-term creditors are probably more focused on this as short-term creditors hope to be repaid quickly enough that they are more concerned about the liquidity issues. Stockholders are concerned because if the firm is unable to meet its debt obligations it will be forced into bankruptcy and the stockholders will likely lose all of their investment.

Profitability Ratios  are a concern primarily for management, competitors, and stockholders. Creditors, both LT and ST, do not participate in profits so their only concern with profitability ratios is if they are negative and threaten the ability of the firm to meet interest and principal payments. Like asset management ratios, competitors use profitability ratios as a method to gauge their strengths and weaknesses. Since stockholders “own” the business, the profits belong to them. Therefore, the stronger the profitability ratios, the happier the stockholders are.

Market Value Ratios  are looked at by stockholders and management. These ratios measure how “cheap” or “expensive” the stock is. Management typically wants these ratios to be high as it is a sign that they are maximizing firm value. Potential stockholders typically want them low as that is an indication that the stock may be cheap (except for dividend yield). As a side note, market value ratios are often much more difficult to analyze than many people would like.

The key to this question recognizing the role of the equation A = L + OE in these two ratios. Because all firms use some degree of liabilities (long-term debt, accounts payable, accruals, etc.), we know that Assets must be larger than Owners' Equity. The greater the amount of debt financing (liabilities), the greater the difference between Assets and Owners Equity will be. Also, since the difference between ROA and ROE is the denominator (ROA is NI/Assets while ROE is NI/OE), ROE will always be higher than ROE (for firms with positive NI). Finally, the greater the amount of debt financing (liabilities), the greater the difference between ROA and ROE will be.

When considering the above paragraph, we can now comment on the specific ROA and ROE numbers for Company A and B. Since Company B has a lower ROA and a higher ROE (relative to Company A), we know that Company B is using more leverage (debt financing) than Company A.

Neither approach is necessarily “better” or “worse” than the other. They are just different. Company B is using a more aggressive (riskier) strategy of financing. The higher level of debt increases the risk, but also means stockholders earn a greater return on their money when the company does well. However, if the company does poorly, the higher leverage (debt financing) will magnify the losses (as the interest must still be paid and the loss is spread over less shareholder capital). Thus, higher amounts of debt financing are riskier, but also increase the potential return. Which approach is better depends on the level of risk aversion for each shareholder.

The DSO ratio does provide an indication of how long it is taking a firm to collect its credit sales. Thus, a high DSO ratio can be an indication of a problem in managing a firm's accounts receivables. However, one must be very careful in jumping to conclusions. First, DSO can be very industry dependent. Second, and the issue in this question, is that DSO uses both balance sheet and income statement values to calculate the ratio. As the Annual Income statement is not subject to seasonality while the Annual Balance Sheet is, there is the potential for seasonality issues to distort the ratio. Specifically, Company A has larger accounts receivable on their annual balance sheet due to the seasonal nature of their sales. This inflates their DSO ratio. Company B has had plenty of time to collect their accounts receivable. This is a prime example of why you need to consider seasonality when evaluating ratios.

If we think of the inventory turnover ratio, Company A should appear to be doing better. Specifically, they will have less inventory on hand at the end of the year (as their heavy sales season is winding down and they approach seasonally lower sales). Alternatively, Company B's inventory will be high to meet their seasonally high 1st and 2nd quarter sales that are right around the corner.

Subject to Seasonality – Quarterly Income Statement, Quarterly Balance Sheet, Annual Balance Sheet

Not Subject to Seasonality – Annual Income Statement

This is a FALSE statement. While it is true that everything else equal, a higher profit margin is better than a lower profit margin there is not enough information to make this a true statement. We are ignoring both trend analysis and comparative analysis, so we don't have the necessary context to evaluate the profit margin number. For instance company A could be in a low profit margin industry (such as banking or retail) while company B could be in a high profit margin industry (such as software or pharmaceuticals). Also, profit margin is only one ratio and to label one company as outperforming another based on a single ratio is shortsighted. We need to consider the larger picture before making such a statement. The purpose of this question is to illustrate that one ratio without context is close to meaningless.

Trend Analysis refers to looking at a firm's ratios over a period of 3-5 years to identify whether specific areas are strengthening or weakening. Comparative analysis refers to looking at a firm's ratios relative to other firms in the same industry to evaluate whether they are better or worse than industry averages. Trend/comparative analysis provides us some of the necessary context to properly interpret the ratios.

QUESTION 10

Potential problems with trend analysis include

Potential problems with comparative analysis include

QUESTION 11

A very low quick ratio may be cause for concern because it could indicate liquidity concerns. A low level of cash and accounts receivable relative to our current liabilities could indicate that we will have a hard time paying those current liabilities when they are due. A very high quick ratio may be cause for concern because it indicates an inefficient allocation of resources. Cash and accounts receivable are not high return assets. We would likely be better off allocating our assets to areas with higher rates of return.

QUESTION 12

The primary objective of financial statement analysis from the perspective of management is to identify potential strengths and weaknesses of our firm relative to our competitors so we can take full advantage of our strengths and work on fixing our weaknesses.

There are several difficulties that management might encounter in conducting a complete financial statement analysis. Some are mentioned in the question on potential problems with trend analysis and comparative analysis above. Other problems include comparability of financial statements across firms in the industry due to different fiscal years and/or different accounting procedures. Also, the need to dig beyond the numbers is critical. For example, is a high ROE due to a well-run company or due to too much leverage that could cause significant problems if we hit a small rough patch? Another issue is that financial statement analysis may help us identify potential strengths and weaknesses. However, even after confirming them by digging deeper, the financial statement analysis often does not recommend HOW we can fix the weakness or exploit the strength.

The primary objective of financial statement analysis from the perspective or the stockholder is to identify companies to invest in (potential stockholders) or evaluate the companies the stockholder currently owns (current stockholders).

Stockholders face many of the same problems discussed above with management. However, an important challenge for stockholders is that they must not only analyze the company's financial health, but also evaluate how much they are paying for it. There may be situations where buying stock in a company with poor financial health is a good opportunity (the stock price is “cheap” enough and there is a chance for the company to rebound). There may also be situations where selling shares of stock in a company with strong financial health is good (the stock price is so expensive that the firm's success is already more than fully reflected in the stock price). Too often stockholders get caught up in what they are buying and don't think enough about how much they are paying for it.

CR = CA/CL = 7,000,000/4,500,000 = 1.56 QR = (CA – Inv)/CL = (7,000,000 – 2,000,000)/4,500,000 = 1.11 ITR = CGS/Inv = 6,000,000/2,000,000 = 3 times DSO = AR/(Sales/365) = 2,000,000/(15,000,000/365) = 48.67 days FAT = Sales/Fixed Asst = 15,000,000/10,000,000 = 1.5 times TAT = Sales/Total Asst = 15,000,000/17,000,000 = 0.88 times TD/TA = 10,000,000/17,000,000 = 58.8% TD/OE = 10,000,000/7,000,000 = 142.86% TIE = EBIT/Int = 4,000,000/1,000,000 = 4 times GPM = (Sales – CGS)/Sales = (15,000,000 – 6,000,000)/15,000,000 = 60% NPM = NI/Sales = 2,100,000/15,000,000 = 14.0% ROA = NI/Asst = 2,100,000/17,000,000 = 12.4% ROE = NI/OE = 2,100,000/7,000,000 = 30.0% PE = Price/EPS = 25/1.05 = 23.81 M/B = Price/BV = 25/(7,000,000/2,000,000) = 7.14 DY = Div/Price = $0.50/$25 = 2.00%

CR = CA/CL = 11,050,000/7,000,000 = 1.58 QR = (CA – Inv)/CL = (11,050,000 – 4,000,000)/7,000,000 = 1.01 ITR = CGS/Inv = 11,000,000/4,000,000 = 2.75 times DSO = AR/(Sales/365) = 4,000,000/(20,000,000/365) = 73 days FAT = Sales/Fixed Asst = 20,000,000/11,000,000 = 1.82 times TAT = Sales/Total Asst = 20,000,000/22,050,000 = 0.91 times TD/TA = 15,000,000/22,050,000 = 68.0% TD/OE = 15,000,000/7,050,000 = 212.77% TIE = EBIT/Int = 3,000,000/1,500,000 = 2 times GPM = (Sales – CGS)/Sales = (20,000,000 – 11,000,000)/20,000,000 = 45% NPM = NI/Sales = 1,050,000/20,000,000 = 5.25% ROA = NI/Asst = 1,050,000/22,050,000 = 4.76% ROE = NI/OE = 1,050,000/7,050,000 = 14.89% PE = Price/EPS = 17.5/0.525 = 33.33 M/B = Price/BV = 17.5/(7,050,000/2,000,000) = 4.96 DY = Div/Price = $0.50/$17.50 = 2.86%

Each item in the income statement is expressed as a percentage of sales (revenues) and each item in the balance sheet is presented as a percentage of total assets.

To start the analysis of finding strengths and weaknesses, I started with the common size statements. The first thing that I noticed was the increase in Cost of Goods Sold from 40% of sales in 2015 to 55% of sales in 2017. This indicates that our production costs jumped significantly and will act to lower our net income. Selling and Administrative expenses dropped slightly from 20% of sales to 17.5% of sales. This is a strength, but is not a very large change so I don't place much emphasis on it. The declines in EBIT and Net Income as a % of sales are due to the increase in CGS, so do not need further analysis. Thus, from the Common Size Income statement, I focus on the increase in CGS as a significant weakness and would classify the decline in S&A Expenses as a small strength.

Next I proceed to the Common Size balance sheet. The first things I notice are the increases in accounts receivable and inventory as a % of total assets. This is a concern that needs more analysis before I declare it a weakness. Consider accounts receivable first. AR could increase due to higher sales levels. If 25% of my sales are done on credit and sales increase, my AR will automatically increase as well. This could result in AR being a bigger portion of my firm's assets and would not be seen as a negative. On the other hand, AR may be increasing because fewer customers are paying their bills on time. This could lead to more bad debt expense or higher collection costs. I can not tell which explanation is causing the increase in AR from the CS balance sheet, so I will make a note of it and look more at the issue as I move through my analysis. Like AR, inventory increases may or may not be a weakness. If sales increase, I will need more inventory on hand to handle the increase in sales which is likely to cause inventory to make up a larger portion of my firm's assets. Alternatively, if I am getting stuck with more out-of-date inventory it will also make up a larger portion of my firm's assets until I am forced to do a write down and take the loss. From the CS balance sheet I can't tell which scenario is taking place so this is also something to investigate further.

Net PPE shows a large drop in the CS Balance sheet, but that is primarily a result of the increase in current assets caused by the jump in AR and Inv which have already been discussed, so I will not pay much attention to the decline in Net PPE. Notes Payable shows a large jump, however that could just be a function of me financing some of my increase in current assets so again that is not something that would concern me too much. I would probably want to note it and make sure I find out the reason for the increase but it likely is not a strength/weakness. The jump in Total Liabilities as a % of total assets is something that might concern me. Higher levels of liabilities as a % of total assets indicates higher risk levels. The firm has a greater chance of serious financial problems is there is a slowdown. This is not necessarily bad as the higher debt levels also have the chance to increase our profits if things go well, however it is something to note with a degree of caution due to the higher risk. Finally, the drop in OE is merely the flip side to the increase in TL, so needs no further analysis.

Next I move on to the ratio analysis. My liquidity ratios appear to be sound as both are stable from year to year and similar to the industry averages. Next is my Inv. Turnover Ratio. This, combined with the increase in inventory on the CS balance sheet indicates a problem. If my inventory increase was merely a result of increased sales, the inventory turnover ratio would hold steady or increase slightly. Instead it has decreased slightly and is noticeably lower than the industry average. This means that I am tying up more of my capital as inventory and probably ending up with older inventory that will need to be marked down and sold at a loss.

I also notice problems with my Days Sales Outstanding ratio. The significant jump in the DSO ratio tells me its taking me an about 24 days longer on average to collect each dollar in sales. Since this is also much higher than the industry average it means one of two things. Either I have a lot of customers that aren't paying on time and may end up with higher levels of bad debts or that I have to offer more favorable credit terms to my customers to keep sales from dropping. Both of these possibilities are bad, so my accounts receivable situation is a definite cause for concern.

Fixed Asset Turnover and Total Asset Turnover both look good. FAT is up and both are higher than the industry average. This is a sign that I am doing a good job overall of using my assets (especially my LT assets) to generate sales.

The debt management ratios are troublesome. My TD/TA and TD/OE ratios have increased by quite a bit and are higher than the industry averages. Also, my TIE ratio has dropped and is lower than the industry average. This means that our firm is using more debt financing and has less margin for error. If we experience an off year or two our firm is likely to run into severe financial problems and could face bankruptcy. On the other hand, if we have a couple of strong years, we will make higher returns for our shareholders due to the leverage provided by debt. This is not necessarily a strength/weakness but is a sign of high financial risk.

The profitability ratios are all showing an interesting pattern that ties back into my CGS observation from the CS income statement. My profitability (PM, ROA, ROE) is down due to the increase in CGS. However, all three ratios are consistent with the industry average. This might be an indication that the increase in CGS is more of an industry issue rather than firm specific. If a key input had a price increase, this is likely to impact all firms in the industry equally. For example, if grain prices jumped significantly both Kellogg's and General Mills may see a jump in their CGS and a decline in their profit margins. It doesn't indicate a management problem, but an industry issue. If my profitability ratios declined significantly AND were lower than the industry average I would be more concerned about company specific problems.

Finally we have the market value ratios which are difficult to interpret in this instance. The PE ratio has increased significantly as my stock price fell, but earnings fell faster. It is also higher than the industry average which indicates the stock is more expensive in terms of what investors pay for each dollar of earnings (possibly indicating that they believe the earnings drop is not permanent). The MV/BV ratio has decreased significantly which indicates the stock is cheaper. This is because book value is less sensitive to the recent earnings decline which lowered the stock price (making the stock cheaper relative to its book value). However, the stock is still slightly more expensive than the industry average. While our dividend yield increased and is higher than the industry average (which is good), there is a danger sign here. If earnings drop any further, we may have to cut our dividend which would cause the yield to drop.

To summarize, our financial statement analysis indicates

• The firm needs to address the CGS issue, but that it is probably an industry issue instead of a company specific problem. This doesn't mean we can ignore it, just that it will be more difficult to fix.
• The firm needs to get control of its credit policies and improve its collections process.
• The firm needs to get control of its inventory concerns
• The firm is doing a good job at generating sales from its LT Assets.
• The firm has a high degree of financial risk
• The firm does not appear to have any major liquidity constraints.
• The stock is relatively expensive relative to the industry average and the dividend yield (while attractive) should be viewed with caution as it may not be sustainable.

You know that you need the current stock price and the book value per share in order to get the MV/BV ratio. To get current stock price, you can use the PE ratio: PE = Price/EPS ⇒ Price = (PE)×(EPS)

To get EPS, you need Net Income which you can get from the net profit margin: Net Profit Margin = Net Income/Sales ⇒ Net Income = Net Profit Margin×Sales

You have the Profit Margin, so you need Sales. You can get Sales from the Total Asset Turnover Ratio: Total Asset Turnover = Sales /Assets ⇒ Sales = TA Turnover×Assets

Sales = (1.5)×($6,000,000) = $9,000,000 Net Income = (0.05)×($9,000,000) = $450,000 EPS = ($450,000)/(600,000 shares) = $0.75 per share Stock Price = (13)×(0.75) = $9.75

Now you need to solve for Book Value which is Owners' Equity per Share. We know the Return on Equity, so we can use that (along with Net Income) to get Owners' Equity: ROE = Net Income/Owners Equity ⇒ Owners Equity = NI/ROE

Owners' Equity = ($450,000)/(0.14) = $3,214,285.71 Book Value = $3,214,285.71)/(600,000 shares) = $5.36 per share MV/BV = ($9.75)/($5.36) = 1.82

Our MV/BV ratio is 1.82. This is a tough problem as it not only tests your knowledge of ratios, but your problem solving skills. Don't worry if you didn't get it at first, but hopefully once you see the solution it makes sense.

Problem Set A

LO 9.1 Prepare journal entries for the following transactions from Barrels Warehouse.

LO 9.1 Prepare journal entries for the following transactions of Dulce Delights.

LO 9.1 Prepare journal entries for the following transactions from Forest Furniture.

LO 9.2 Jars Plus recorded $861,430 in credit sales for the year and $488,000 in accounts receivable. The uncollectible percentage is 2.3% for the income statement method, and 3.6% for the balance sheet method.

• Record the year-end adjusting entry for 2018 bad debt using the income statement method.
• Record the year-end adjusting entry for 2018 bad debt using the balance sheet method.
• Assume there was a previous debit balance in Allowance for Doubtful Accounts of $10,220, record the year-end entry for bad debt using the income statement method, and then the entry using the balance sheet method.
• Assume there was a previous credit balance in Allowance for Doubtful Accounts of $5,470, record the year-end entry for bad debt using the income statement method, and then the entry using the balance sheet method.

LO 9.2 The following accounts receivable information pertains to Luxury Cruises.

• Determine the estimated uncollectible bad debt for Luxury Cruises in 2018 using the balance sheet aging of receivables method.
• Record the year-end 2018 adjusting journal entry for bad debt.
• Assume there was a previous debit balance in Allowance for Doubtful Accounts of $187,450; record the year-end entry for bad debt, taking this into consideration.
• Assume there was a previous credit balance in Allowance for Doubtful Accounts of $206,770; record the year-end entry for bad debt, taking this into consideration.
• On January 24, 2019, Luxury Cruises identifies Landon Walker’s account as uncollectible in the amount of $4,650. Record the entry for identification.

LO 9.2 Funnel Direct recorded $1,345,780 in credit sales for the year and $695,455 in accounts receivable. The uncollectible percentage is 4.4% for the income statement method and 4% for the balance sheet method.

• Assume there was a previous credit balance in Allowance for Doubtful Accounts of $13,888; record the year-end entry for bad debt using the income statement method, and then the entry using the balance sheet method.

LO 9.3 Review the select information for Bean Superstore and Legumes Plus (industry competitors), and then complete the following.

• Compute the accounts receivable turnover ratios for each company for 2018 and 2019.
• Compute the number of days’ sales in receivables ratios for each company for 2018 and 2019.
• Determine which company is the better investment and why. Round answers to two decimal places.

LO 9.3 The following select financial statement information from Candid Photography.

Compute the accounts receivable turnover ratios and the number of days’ sales in receivables ratios for 2018 and 2019 (round answers to two decimal places). What do the outcomes tell a potential investor about Candid Photography if industry average for accounts receivable turnover ratio is 3 times and days’ sales in receivables ratio is 150 days?

LO 9.4 Noren Company uses the balance sheet aging method to account for uncollectible debt on receivables. The following is the past-due category information for outstanding receivable debt for 2019.

To manage earnings more favorably, Noren Company considers changing the past-due categories as follows.

• Complete each table by filling in the blanks.
• Determine the difference between totals uncollectible.
• Complete the following 2019 comparative income statements for 2019, showing net income changes as a result of the changes to the balance sheet aging method categories.
• Describe the categories change effect on net income and accounts receivable.

LO 9.4 Elegant Universal uses the balance sheet aging method to account for uncollectible debt on receivables. The following is the past-due category information for outstanding receivable debt for 2019.

To manage earnings more favorably, Elegant Universal considers changing the past-due categories as follows.

LO 9.6 Record journal entries for the following transactions of Telesco Enterprises.

LO 9.6 Record journal entries for the following transactions of Wind Solutions.

LO 9.6 Record journal entries for the following transactions of Commissary Productions.

LO 9.6 Record journal entries for the following transactions of Piano Wholesalers.

LO 9.7 Organics Plus is considering which bad debt estimation method works best for its company. It is deciding between the income statement method, balance sheet method of receivables, and balance sheet aging of receivables method. If it uses the income statement method, bad debt would be estimated at 4% of credit sales. If it were to use the balance sheet method, it would estimate bad debt at 12% of accounts receivable. If it were to use the balance sheet aging of receivables method, it would split its receivables into three categories: 0–30 days past due at 6%, 31–90 days past due at 19%, and over 90 days past due at 26%. There is currently a zero balance, transferred from the prior year’s Allowance for Doubtful Accounts. The following information is available from the year-end income statement and balance sheet.

There is also additional information regarding the distribution of accounts receivable by age.

Prepare the year-end adjusting entry for bad debt, using

• Income statement method
• Balance sheet method of receivables
• Balance sheet aging of receivables method.
• Which method should the company choose, and why?

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• Authors: Mitchell Franklin, Patty Graybeal, Dixon Cooper
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• Book title: Principles of Accounting, Volume 1: Financial Accounting
• Publication date: Apr 11, 2019
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• Section URL: https://openstax.org/books/principles-financial-accounting/pages/9-problem-set-a

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CPS MATERIALS AND PAPERWORK

All the resources you need to implement the CPS Model are here.

CPS MATERIALS/PAPERWORK

Here’s all the paperwork — the resources and instruments — and research related to the CPS model.

Assessment of Skills and Unsolved Problems (ASUP 2024)

The recently revised is Assessment of Skills and Unsolved Problems (ASUP 2024) used to identify the skills that may be making it difficult for a kid to respond adaptively to problems and frustrations or meet certain expectations, and the unsolved problems that need to be solved. It’s printable/editable/fillable, or you can access it as a Google Doc (directions for making a copy can be found here ).

The  ASUP Guide provides helpful guidelines for completing the ASUP 2024.

DRILLING CHEAT SHEET

The Drilling Cheat Sheet   provides an overview of the drilling strategies that can be used to gather information in the Empathy step of Plan B.

PLAN B CHEAT SHEET

The Plan B Cheat Sheet provides a graphic overview of the key components you’ll want to keep in mind when you’re doing Plan B.

PROBLEM SOLVING PLAN

The Problem Solving Plan helps you keep track of the high-priority unsolved problems you’re currently working on and the progress you’re making in solving them, and it’s printable/editable/fillable too.

PROBLEM SOLVING REFERRAL FORM

The Problem Solving Referral Form was created to help schools shift from discipline referrals to referrals that prompt scheduling time for Plan B. You can tailor it to the needs of your school.

MEETING CHECKLISTS

This is where to find the Plan-B-Checklist and ALSUP Meeting Checklist …so you can self-assess how you did.

PLAN B TRAINING SKILLS INFOGRAPHIC

Want to know what skills are being built by Plan B? Check out this graphic (with thanks to certified provider Linda Oberg for creating).

FIVE FINGERS METHOD

If you’re trying to solve a problem with a child or adolescent who’s having difficulty providing you with information in the Empathy step, you may find that five fingers can help you get the information you’re seeking (with thanks to certified provider Jodell Allinger for creating).

CPS-INFLUENCED IEP & FBA SAMPLES

You can find a CPS-flavored sample IEP for the US  here , and one for Canada here . And here’s our original CPS-flavored Functional Behavior Assessment , along with a new hybrid FBA (created in collaboration with Abigail Wallman, Ph.D., school psychologist in the Farmington [CT] Public Schools).

CPS MODEL ONE-PAGER

And here’s a one-page description of the Collaborative & Proactive Solutions approach.

PROBLEMS AND SOLUTIONS IN PICTURES

LENS CHANGER APP

Our Lens Changer app sure does make it easy to apply the CPS model. For iOS, click here . For Android, click here .

The Collaborative & Proactive Solutions* model is recognized as an empirically-supported, evidence-based treatment by the  California Evidence-Based Clearinghouse for Child Welfare (CEBC). The research base supporting the effectiveness of the CPS model continues to grow, and this page is updated continuously. Learn more .

CPS MATERIALS IN OTHER LANGUAGES

Many of these materials have been translated into other languages, and we’re in the midst of updating them so they reflect the most current renditions:

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10 Balance Sheet Questions for Practice 

10 balance sheet questions for practice.

From the following particulars are given after preparation of income statement, prepare a balance sheet of JKS as at 31st March 2021 Non-Current Assets $50000 Current Assets $30000 Non-Current Liabilities $25000 Current Liabilities $15000 Capital $45000 Net Profit$15000 Drawings$20000 Answer: Total of  Balance Sheet $80000 Question 2

From the following particulars are given after preparation of income statement, prepare a balance sheet of JKR as at 31st March 2021 Non-Current Assets Premises $80000 Plant&Machinery$40000 Furniture and Fitting$30000 Vehicles$50000 Current Assets Inventory$15000 Trade Receivable $25000 Bank$10000 Non-Current Liabilities Loan From ABC Bank$70000 Current Liabilities  Trade payable $30000 Capital $100000 Net Profit$60000 Drawings$10000 Answer: Total of  Balance Sheet $250000 Question 3

From the following particulars are given after preparation of income statement, prepare a balance sheet of MRS as at 31st March 2021 Non-Current Assets Premises $85000 Plant&Machinery$45000 Furniture and Fitting$30000 Vehicles$52000 Computer$18000 Goodwill$40000 Current Assets Inventory$15000 Trade Receivable $25000 Bank$12000 Cash In Hand $8000 Non-Current Liabilities Loan From ABC Bank$90000 Current Liabilities  Trade payable $30000 Outstanding Expenses$15000 Capital $150000 Net Profit$60000 Drawings$15000 Answer: Total of  Balance Sheet $330000

From the following particulars are given after preparation of income statement, prepare a balance sheet of SJMR as at 31st March 2021 Land and Building $300000 Plant &Machinery $150000 Investments in P.ltd $150,000 Furniture $15000 Trade Receivable $85000 Inventory$125000 Cash in Hand $ 15000 Loan from XYZBank $100000 Net Profit $140000 Trade payable $200000 Capital $400000 Answer: Total of  Balance Sheet $840000

From the following particulars are given after preparation of income statement, prepare a balance sheet of J.M.R as at 31st March 2021 Land and Building $300000 Loan from Bank $400000 Outstanding Expenses $1200 Drawings $72000 Net Profit $43000 Investments $150000 Computers $70000 Furniture $55000 Trade payable $105300 Trade Receivable $87500 Inventory$125000 Cash in Hand $ 15700 Prepaid Expenses $3600 Capital $450200 Computer $16000 Machinery $85000 Vehicles$22200 Income Received in Advance$2300 Answer: Total of  Balance Sheet $930000

The following trial balance is prepared after the preparation of the income statement, prepare a balance sheet of J.BHAR as at 31st March 2021.

Trial Balance As on 31 st March 2021

Answer: Total of  Balance Sheet $10000

The following trial balance is prepared after the preparation of the income statement, prepare a balance sheet of JRT as at 31st March 2021.

Answer: Total of  Balance Sheet $215000

The following trial balance is prepared after the preparation of the income statement, prepare a balance sheet of A.Smolly as at 31st March 2021.

Trial balance

As on 31 st March 2021

Answer: Total of  Balance Sheet $ 37000

The following trial balance is prepared after the preparation of the income statement , prepare a balance sheet of JKL as at 31st March 2021.

Trial balance As on 31 st March 2021

Answer: Total of  Balance Sheet $ 71200

Question 10

The following trial balance is prepared after the preparation of the income statement, prepare a balance sheet of SUV as at 31st March 2021.

Answer: Total of  Balance Sheet $ 85200

Balance Sheet Questions for Practice

Cash Sales Journal Entry

Bad Debts Recovered Journal entry

Types of assets/ list of assets

Outstanding Salary Journal Entry

Commission received journal entry

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