What is a balance sheet?
The columns of numbers in company balance sheets put off many investors. However, they lose their horror if you understand the system. First of all, a balance sheet is nothing more than a comparison of assets and debts till the last day of the year. These two pillars of a balance sheet are always the same.
- The assets side …
… shows the assets valued in money. It is divided into fixed assets and current assets. Fixed assets include intangible assets, tangible assets and financial assets. To current assets. For example, inventories, receivables, securities and cash on hand are counted.
- The liabilities side
…… shows the liabilities. The term is initially misleading. Because the sources of finance from which the fortune was fed are listed. This includes equity and provisions as well as liabilities.
How much room for maneuver is there in balance sheets?
- Basically, the balance sheet should provide as precise information as possible about a company’s assets. That is the duty of an accountant. But by no means all assets and obligations can be assigned a completely objective value. Accordingly, there is scope for management in the balance sheet, which can be used very differently depending on the interests involved. Specifically, this means that profits and losses are kept high or low as required, whereby the motives can be diverse:
- When a public company is under pressure from critical shareholders to post high profits, assets tend to be valued higher.
- If corporate taxes fall next year, profits should be kept rather low this year.
When a new CEO takes office, he wants to start on the lowest possible basis. Because then he can make improvements in results on his own behalf.
- Scope 1: Intangible assets
- Scope 2: R&D costs
- Scope 3: provisions and liabilities
The second item is made up of provisions. Pension obligations are an important branch of provisions. For some companies, this position is highly explosive due to its size. This is especially true for industrial groups with a large number of older employees. In these companies, the pension provisions often make up more than 20% of the current stock market valuation. For shareholders, high pension obligations are a problem above all if they are not covered by corresponding pension assets. In the “other provisions” collection pool, company executives book;
- for process costs,
- for legal or contractual guarantee obligations,
- for bills of exchange or guarantees,
- for threatened loss-making deals.
If the “other provisions” are particularly high, the alarm bell should ring. Balance sheet professionals sense future business risks here. The third liability item is liabilities. Including: bonds, credits, down payments or liabilities from investments.
Outstanding tax debts, social security claims or existing claims for damages by third parties are booked under “other liabilities”. In contrast to provisions, liabilities involve only a few risks, as they are already precisely quantified.
- Scope 4: company values and goodwill
Warning signs for shareholders
It is difficult to see through whether and how companies use their creative leeway exactly. However, shareholders should follow the development of the most important balance sheet items. If the profit jumps up for no apparent reason, the result may have been embellished by one-off sales or neglected value adjustments. Caution is also advised if the assets side consists predominantly of intangible assets, group subsidiaries accumulate high debts or assets have been parked with minority interests. In case of doubt, only one thing helps: ask experts.