• Financial management

• The balance sheet

Index

01. Introduction
02. The Balance sheet
03. Example
04. Book value and market value
05. Exercises

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01. Introduction

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01. Introduction
 Accounting is an information system to identify, measure, record and report the
economic transactions of a company.
 Financial accounting
• It includes all external transactions.
• It provides information for all stakeholders: shareholders, lenders, customers, suppliers,
employees, regulators, government.
 In addition, there is also Cost Accounting or Managerial Accounting
 A basic rule is the double-entry system: all and every transactions must be recorded
twice, in two different accounts. One is the counterpart of the other.
 International Financial Reporting Standards (IFRS) is a set of rules that are followed
by professional in most countries. But in EEUU slightly different rules apply, known as
Generally Accepted Accounting Principles (GAAP).

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01. Introduction
MAIN FINANCIAL STATEMENTS

Based on the accounting information, several “reports” are elaborated, called Financial Statements. They
record a company’s operating performance over a specific period. The most relevant are:

 Balance sheet, that shows at a given moment all the resources owned by the company and how they
are funded, that is, where the money comes from.

 Profit & Loss Account, which reports how much money the company has earned o lost during a given
period, usually a year.

 Cash Flow statement, which presents all cash movements during a given period, normally a year.

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01. Introduction
MAIN FINANCIAL STATEMENTS

 Most of the information we need in financial analysis comes from the accounting
statements.

 These three “reports”, along with others less relevant, are included in the Annual Report that
all listed companies must prepare annually.

 The Annual Report includes the auditors’ report.

 The Annual Report also contains several Notes to explain in more detail the information
shown in the financial statements.

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02. The Balance sheet

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02. Balance sheet
A balance sheet summarizes what a firm owns
and owes at a specific date

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02. Balance sheet
A balance sheet reports a company’s financial position at a specific date

 A company’s balance sheet has assets on the left- Balance sheet

hand side and liabilities and equity on the right-
hand side. Owners’
Equity
 Assets are the resources a company employs to
generate cash flows.
Assets
 Liabilities and equity are the way a company funds
the assets. Liabilities
 Debt and equity are the most popular forms of
funds.
 Due to the double-entry principle, the balance
sheet is always balanced.

Basic equation: Assets - Liabilities = Owners’ equity

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02. Balance sheet
What can be found in Assets?. Examples:
1. Goods (tangible and intangible)
• Software systems
• Land
• Buildings
• Equipment
• Furniture
• Stakes in other companies
• Patents
• Inventories
• Cash
• …..
2. .. but also claims
• Customers debts
• Loans granted
• …..

….. Other “assets” such as human resources, environmental strengths or brand value are not included.
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02. Balance sheet
What can be found in Liabilities?

• Long-term and short-term debts

• Debts with providers and suppliers
• Government (taxes)
• Interests accrued and not paid yet
• Wages not paid yet
• Leases
• ….

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02. Balance sheet
What can be found in Owners’ Equity?

• Share capital
• Additional paid-in capital
• Retained earnings (or accumulated deficit)
• Net income for the year (before distribution of dividends, if any)

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02. Balance sheet
Order to present the Balance Sheet (depending on the countries)
Equity +
Assets Liabilities

Less liquid More maturity

EQUITY
NON
CURRENT
ASSETS

NON
CURRENT
LIABILITIES
CURRENT
ASSETS CURRENT
LIABILITIES
More liquid Less maturity

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02. Balance sheet
Telefónica Group Consolidated Balance sheet
Million of euros

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Iberdrola Group Consolidated Balance sheet. Million of euros

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 Apple Inc.
Consolidated Balance Sheet. In millions

ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY

Common stock and additional paid-in capital

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 SOME PARTICULAR ITEMS

02. Balance sheet

Telefónica Group Consolidated Balance sheet
Million of euros

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02. Balance sheet
Some interesting accounts in the balance sheet

 Goodwill. It is the money paid in excess over book value when another company is acquired.
 Ex. A company is purchased for 100, but assets in the balance sheet are only valued for 80. The difference (20) is the Goodwill.

 Right of use assets. It is about leased assets.

 Leases (on the Liabilities side). It is the counterpart of the previous one.

 Non-controlling interests (minority interests). It is the portion of the assets that doesn’t belong to the company’s shareholders. It
appears when a company is bought for less than 100% but for a sufficient stake to control it. In this case, the assets of the acquired
company are added up to 100% to the balance of the acquirer company, but there is a portion that belongs to the minority shareholders of
the acquired company.

 Deferred tax assets and deferred tax liabilities. They appear due to the differences between the accounting net profit and the tax
profit. They also appear due to loss in one year that can be used to compensate future profitable years. Deferred tax assets mean that
future tax payments will be lower. Deferred tax liabilities mean that future tax payments will be greater. Assets and liabilities cannot be
offset.

 Property, plant and equipment. It refers to the gross cost of acquisition of Property, plant and equipment, net of accumulated
depreciation. Depreciation is the allocation of cost of a tangible or physical asset over its useful life.

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02. Balance sheetAssets, Liabilities or Shareholders’ equity?
Machinery A/L/E Taxes not paid yet A/L/E

Retained earnings /Accumulated deficit A/L/E Cash in bank A/L/E

Debts with providers A/L/E Patents A/L/E

Common stocks A/L/E Raw materials in the warehouse (inventories) A/L/E

Dividend pending payment A/L/E Accrued interest, to be paid next month A/L/E

Six months bank debt A/L/E Land where facilities are located A/L/E

Telefonica bonds acquired last year A/L/E Payroll to be paid next week A/L/E

Revenues paid in advance A/L/E Goodwill A/L/E

Raw material purchased on credit A/L/E 10 years bank debt A/L/E

Subscribed capital A/L/E

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02. Balance sheet
Suppose that a company get a loan of $500 million over 20 years. It
uses $400 million to buy new machinery and leaves the remainder in
cash.
What items of the balance sheet would change? Would shareholders’
equity change?

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03. Example

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03. Example
1. We set up a company with 10.000€, paid in cash

Assets = Liabilities + Owners’ Equity

Cash Common stock

+10.000 +10.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000

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03. Example
2. A bank gives us a long-term loan for 3.000 €

Assets = Liabilities + Owners’ Equity

Cash Long-term debt

+3.000 +3.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000
+3.000 +3.000

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03. Example
3. We purchase machinery for 5.000 €, paid in cash

Assets = Liabilities + Owners’ Equity

Cash Non-current asset

-5.000 +5.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000
+3.000 +3.000
-5.000 +5.000

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03. Example
4. We provide services to a customer for 12.000 €. The customer pays 8.000 € in cash and the remainder will
be paid later

Assets = Liabilities + Owners’ Equity

Cash Receivables Net income

+8.000 +4.000 +12.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000
+3.000 +3.000
-5.000 +5.000
+8.000 +4.000 +12.000

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03. Example
5. The expenses for the year (labor costs, interest expenses, utilities and other expenses) amount 9.000
€, paid in cash.

Assets = Liabilities + Owners’ Equity

Cash Net income

-9.000 -9.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000
+3.000 +3.000
-5.000 +5.000
+8.000 +4.000 +12.000
-9.000 -9.000

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03. Example
6. We pay dividends for 1.000 €

Assets = Liabilities + Owners’ Equity

Cash Net income

-1.000 -1.000

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03. Example
ASSETS LIABILITIES + EQUITY
Cash + Other CA + NCA = Liabilities + (Equity + Profit)
+10.000 +10.000
+3.000 +3.000
-5.000 +5.000
+8.000 +4.000 +12.000
-9.000 -9.000
-1.000 -1.000
+6.000 +4.000 +5.000 +3.000 +10.000 +2.000

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03. Example FINAL BALANCE SHEET
Euros

EQUITY +
ASSETS Euros Euros
LIABILITIES

NON-CURRENT
5.000 EQUITY 12.000
ASSETS
CURRENT ASSETS 10.000 Common stocks 10.000
Receivable 4.000 Retained earnings 2.000
Cash 6.000 LIABILITIES 3.000
Long term debt 3.000

Total Equity +
Total Assets 15.000 15.000
Liabilities

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04. Book value and market value

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04. Book value and market value
 In accounting, items in the balance sheet are normally valued on a cost basis.

 That is why commonly book value and market value are not coincident.

 Additionally, there are intangibles not included on the Assets side: brand vallue, reputation, customers
loyalty, managerial skills, etc.

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04. Book value and market value
BOOK BALANCE SHEET

ASSETS 100 SHAREHOLDERS’ EQUITY 40

LIABILITIES 60
TOTAL ASSETS 100 TOTAL EQUITY + LIABILITIES 100

Now let suppose this company is listed in a stock exchange, it has 10 shares outstanding and
current share price is 5. Then, the market value of equity is 10 x 5=50.

What does that mean? It means that the market believes that assets value is 110 (not 100). Market
valuation is related with the expected profits for coming years. The market looks forward and
accounting looks backward.

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05. Exercises 1 and 2

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 We make
it happen

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