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The Balance Sheet

We will look first at the balance sheet, which presents a snapshot of the firm`s assets and the source of the money that was used to buy those assets. The assets are listed on the left-hand side of the balance sheet. Some assets can be turned more easily into cash than others; these are known as liquid assets. The accountant puts the most liquid assets at the top of the list and works down to the least liquid.

Look, for example, at the left-hand column of Table A.1, the balance sheet for PepsiCo, Inc., at the end of 1998. You can see that Pepsi had $311 + $83 = $394 million of cash and marketable securities. In addition it had sold goods worth $2,453 million but had not yet received payment. These payments are due soon and therefore the balance sheet shows the unpaid bills or accounts receivable (or simply receivables) as an asset. The next asset consists of inventories. These may be (1) raw materials and ingredients that the firm bought from suppliers, (2) work in process, and (3) finished products waiting to be shipped from the warehouse. Of course there are always some items that don`t fit into neat categories. So the current assets category includes a fourth entry, other current assets.

Up to this point all the assets in Pepsi`s balance sheet are likely to be used or turned into cash in the near future. They are therefore described as current assets. The next group of assets in the balance sheet is known as fixed assets such as buildings, equipment, and vehicles.

The balance sheet shows that the gross value of Pepsi`s fixed assets is $13,110 million. This is what the assets originally cost. But they are unlikely to be worth that now. For example, suppose the company bought a delivery van 2 years ago; that van may be worth far less now than Pepsi paid for it. It might in principle be possible for the accountant to estimate separately the value today of the van, but this would be costly and somewhat subjective. Accountants rely instead on rules of thumb to estimate the depreciation in the value of assets and with rare exceptions they stick to these rules. For example, in the case of that delivery van the accountant may deduct a third of the original cost each year to reflect its declining value. So if Pepsi bought the van 2 years ago for $15,000, the balance sheet would show that accumulated depreciation is 2 Р РЈР Р· $5,000 = $10,000. Net of depreciation the value is only $5,000. Table A.1 shows that Pepsi`s total accumulated depreciation on fixed assets is $5,792 million. So while the assets cost $13,110 million, their net value in the accounts is only $13,110 $5,792 = $7,318 million.

The fixed assets in Pepsi`s balance sheet are all tangible assets. But Pepsi also has valuable intangible assets, such as its brand name, skilled management, and a well trained labor force. Accountants are generally reluctant to record these intangible assets in the balance sheet unless they can be readily identified and valued.

There is, however, one important exception. When Pepsi has acquired other businesses in the past, it has paid more for their assets than the value shown in the firms` accounts. This difference is shown in Pepsi`s balance sheet as “goodwill.” The greater part of the intangible assets on Pepsi`s balance sheet consists of goodwill.1

Now look at the right-hand portion of Pepsi`s balance sheet, which shows where the money to buy the assets came from. The accountant starts by looking at the company`s liabilities that is, the money owed by the company. First come those liabilities that are likely to be paid off most rapidly. For example, Pepsi has borrowed $3,921 million, due to be repaid shortly. It also owes its suppliers $3,870 million for goods that have been delivered but not yet paid for. These unpaid bills are shown as accounts payable (or payables). Both the borrowings and the payables are debts that Pepsi must repay within the year. They are therefore classified as current liabilities.

Pepsi`s current assets total $4,362 million; its current liabilities amount to $7,914 million. Therefore the difference between the value of Pepsi`s current assets and its current liabilities is $4,362 $7,914 = $3,552 million. This figure is known as Pepsi`s net current assets or net working capital. It roughly measures the company`s potential reservoir of cash. Unlike Pepsi, most companies maintain positive net working capital. Below the current liabilities Pepsi`s accountants have listed the firm`s long-term liabilities that is, debts that come due after the end of a year. You can see that banks and other investors have made long-term loans to Pepsi of $4,028 million.

Pepsi`s liabilities are financial obligations to various parties. For example, when Pepsi buys goods from its suppliers, it has a liability to pay for them; when it borrows from the bank, it has a liability to repay the loan. Thus the suppliers and the bank have first claim on the firm`s assets. What is left over after the liabilities have been paid off belongs to the shareholders. This figure is known as the shareholders` equity. For Pepsi the total value of shareholders` equity amounts to $6,401 million. A small part of this sum ($1,195 million) has resulted from the sale of shares to investors. The remainder ($5,206 million) has come from earnings that Pepsi has retained and invested on shareholders` behalf.

Figure A.1 shows how the separate items in the balance sheet link together. There are two classes of assets current assets, which will soon be used or turned into cash, and long-term or “fixed” assets, which may be either tangible or intangible. There are also two classes of liability current liabilities, which are due for payment shortly, and longterm liabilities. The difference between the assets and the liabilities represents the amount of the shareholders` equity.

BALANCE SHEET

Financial statement that shows the value of the firm`s assets and liabilities at a particular time.