Both Sides Now (Part 2)

We talked about how investors need to use both sides of the humble balance sheet to look for trouble. But how?

Balance sheets are basic. They usually go from the most simple item to the most complex. Assets start with cash, move through inventory, then fixed assets, like property and factories, and end with intangibles: goodwill, trademarks, patents. It’s easy to measure the value of cash or liquid investments. It  becomes progressively more difficult as you move down the page.

The same is true on the other side. Liabilities start with payables, short-term debt, long-term debt, and then equity—what’s left over. There’s a reason why we start at the top and move down: if the creditors walk away, refusing to renew credit lines or short-term loans, there needs to be enough cash on hand to pay them off. A balance sheet that’s out of whack–where there aren’t enough current assets to fund current liabilities—is a balance sheet that’s dangerous.

The balance sheet works with the other financials to give a total picture, but it’s the balance sheet we start with. Another way to look at the balance sheet is to normalize everything. Assume that the assets and liabilities each add up to $100, and each line item is just a portion of that total. It’s easier, then, to see changes in the balance sheet’s structure over time. If something shifts significantly—say, inventory is rising, or plant and equipment is going down—then it indicates that something significant may be going on at the company.

The balance sheet is a start. It gives you snapshot. And looking at how its structure changes over time gives a fuller picture. But the other items—income and cash-flow—work alongside.

By |2017-07-17T12:34:55+00:00March 28th, 2012|Accounting, Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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