FOOL SCHOOL
Balance Sheet Basics: Part I

August 31, 2005

Financial commentators often refer to balance sheets as 'strong' or 'weak'. But as with most well-worn investing terms, such definitions cannot be applied easily to every quoted business. What at first glance looks to be a flimsy balance sheet can sometimes prove attractive to shareholders, while those that appear solid have been found in many a troubled business.

Definition

The balance sheet is an accounting statement that summarises the various assets and liabilities held by a company. It is always drawn up at the close of business on the last day of the company's accounting period (the balance sheet date). The 'net' -- or 'book' -- value of the assets and liabilities is also shown to 'balance' against shareholders' interests in the business. (In this article we'll concentrate on the asset and liabilities. In Friday's Fool School, we'll look how the shareholders' interests in the business are presented.)

Annual reports usually contain two balance sheets. There's the consolidated (or group) balance sheet, which represents the combined assets and liabilities of all the company's subsidiary operations, and is the most important to investors. The other is the company balance sheet, which reflects the assets and liabilities of the parent holding company and can very often be ignored.

Balance sheet

Balance sheets have a traditional presentation format. Assets are listed first, in order of 'illiquidity', followed by short-term liabilities and then long-term and other liabilities.

As an example we're going to use a set of results from tobacco firm Gallaher (LSE: GLH), which includes a balance sheet with most of the common asset and liability components:

Year to December 31	2003 (£)	2002 (£)
Fixed assets:
Intangible assets	1,399	1,375
Tangible assets	595	575
Investments:
- Investment in joint ventures	6	6
- Investment in associate	112	109
- Other investments	19	17
	2,131	2,082
Current assets:
Stocks	504	466
Debtors	783	788
Non-liquid investments	1	1
Cash and liquid investments	116	95
	1,404	1,350
Creditors: amounts falling due within one year:
Borrowings	(139)	(201)
Other	(1,117)	(1,044)
	(1,256)	(1,245)
Net current assets	148	105
Total assets less current liabilities	2,279	2,187
Creditors: amounts falling due after one year:
Borrowings	(2,429)	(2,387)
Other	(5)	(6)
	(2,434)	(2,393)
Provisions for liabilities and charges	(53)	(49)
Net retirement benefits liability	(68)	(82)
Net liabilities	(276)	(337)

Like all financial statements, two years of information are listed side by side to make it easier to spot significant changes.

Here are the definitions to the entries:

Assets: Items that the business owns and on which a value can be placed.

Intangible assets:'Non-monetary' but 'identifiable' assets that have no physical substance. Current accounting guidelines mean they almost always relate to goodwill, though may include patents, licenses, trademarks and so on. Read more on goodwill.

Tangible assets: 'Long-lived' physical items held for the purpose of earning revenue. Typically include land, property, plant, machinery, fixtures, fittings and motor vehicles. Many companies adopt a 'modified historical cost' convention, whereby assets are stated at actual cost less depreciation, but revaluing certain assets (usually land and property) from time to time. Read more on tangible assets.

Fixed asset investments: Long-term investments, including 'ownership interests' held in other companies. For joint ventures and associates (i.e. entities where 'significant influence' can be exerted, but not full control), the company's share of the entity's assets is shown. Other long-term 'minority' investments held can be shown at historical cost or current valuation, though the accounting notes must declare which.

Current assets: Cash in the bank and 'temporary' assets that the company expects to turn into cash. Stocks represent (at the lower of either cost or net realisable value) any goods held for resale, raw materials to be used in manufacture and work in progress. Debtors reflect the amounts owed to the company, with an accounting note itemising the entry (money owed by customers ('trade debtors') is usually the largest). Current asset investments are those investments held with only a short-term intention.

Liabilities: Amounts owed by the business.

Current liabilities: Liabilities the company expects to meet within twelve months of the balance sheet date and usually described as 'creditor amounts falling due within one year'. An accounting note breaks the figure down, with money owed to suppliers ('trade creditors'), taxes and proposed dividends among the more significant sub-entries. Bank loans, overdrafts and financial lease obligations due within a year will be found in the same accounting note.

Read more about current assets and liabilities and some more.

Net current assets: Current assets less current liabilities.

Creditor amounts falling due after one year: Almost always bank loans and debts due for repayment at least one year after the balance sheet date.

Provisions: Technically defined as amounts retained to provide for a liability or loss which is either likely to be incurred, or certain to be incurred but uncertain as to the amount or as to the date on which it will arise. Read more on provisions.

Net retirement benefits asset/liability: Shows the company's pension surplus/shortfall according to FRS 17 reporting standards. Businesses fully adopting FRS 17 place the figure in the consolidated balance sheet. Those firms keeping to the 'transitional' FRS 17 guidelines reveal their pension details in the back of the accounts, which outline the effect of a full FRS17 adoption anyway. Read more on FRS 17.

Net assets/liabilities: Total assets less total liabilities.

> Part II