Balance Sheet
The balance sheet shows what makes up a company; what the company owns, what the company owes, and the value left over for the owners.
Assets are made up of current (short term) and non-current (long term) assets. Current assets (used in daily operations) include cash and cash equivalents, inventory, and accounts receivables (items owed to you). Non-current assets are considered long-term and include property, equipment, intangible assets (branding, trademarks), and long-term investments.
Liabilities are also split into current and non-current. Current liabilities include accounts payable, short-term debt, accrued expenses and unearned revenue. Non-current liabilities include lease liabilities, pension obligations, long term loans, bonds payable, and deferred taxes.
The remaining balance encompasses the value for shareholders, and assets must always balance the liabilities and value for shareholders.
When a company’s liabilities exceed their assets, they are functionally bankrupt; however, they do not have to declare bankruptcy immediately. As long as the company can continue funding their debt obligations (through available cash),they can continue operating.
In Private Equity (PE) today, there are a significant number of companies that are functionally bankrupt. They have made investments (current assets) with investors’ money (non-current liabilities). As investors’ began demanding their money back, PE firms have been forced to halt withdrawals due to having insignificant funds to cover them. The PE firm took investor’s money and locked it up into long term assets that can’t be disposed of immediately.
Under normal circumstances, the PE firm would sell the investment and use the money to fund the withdrawals. The issue with today’s market is that the investments are worth less than they originally were, so there would not be enough funds to pay the investors back. This will be a looming problem as investments are marked on these company’s balance sheets at older values than they actually are. Because when the investments (assets drop), either liabilities or shareholder value needs to drop in tandem, and investors come first when getting paid back…
The balance sheet shows you where you are, the P&L shows you where you’re going, and the cash flow shows you how fast you’re going to get there. Overall these three components are fundamental to understanding your home, your business, your economy.