Step 1: Quick Take: Balance Sheet Analysis

The balance sheet of a company shows a firms assets and liabilities (and stockholders equity). In other words, at any given point in time, the balance sheet illustrates a firms overall financial position. A typical balance sheet shows assets owned by the company on the left, along with the firms liabilities and equity on the right.

The assets are usually organized into two major types: currents assets and fixed (or long-term) assets. Current assets include cash, cash equivalents, accounts receivable, and inventory. These are assets that are expected to be converted to cash in short order. Fixed assets include net plant, property, and equipment, along with other long-term assets.

Similarly, the right side of the balance sheet is usually organized into two major categories: liabilities (money owed by the company) and stockholders equity. Current liabilities are claims that are due within one year. These types of liabilities typically consist of things like accounts payable, accruals, notes payable to banks. Long-term debt can include bonds with maturity dates far into the future. Stockholders equity can be written as either the sum of paid-in capital and retained earnings, or the difference between total assets and total liabilities.

The various financial ratios commonly used to analyze the financial strength of a company can also be used to relate the various entries on the balance sheet together. For example, the current ratio is calculated by dividing current assets by current liabilities. Thus, in theory, if you knew the current ratio and the value of current liabilities, you could solve for the value of current assets by multiplying the current asset ratio by current liabilities.

Additionally financial ratios can also be used to related items from the balance sheet to items in the income statement, such as sales or cost of goods sold. For example, the total assets turnover ratio can be calculated as sales (from the income statement) divided by total assets (from the balance sheet). In theory, if you know the total assets turnover ratio as well as the value of total assets, you can solve for sales by multiplying the total assets turnover ratio by total assets.

True or False: Assets generally appear on the right side of the balance sheet.

True

False

Cash would generally appear under on the balance sheet.

Step 2: Learn: Balance Sheet Analysis

The items on the balance sheet and other financial statements are related in specific ways.

Watch the following video for an example, then answer the questions that follow.

Suppose that Royval Inc has the following data:

Total assets turnover	1.5
Days sales outstanding	36.5 days
Inventory turnover ratio	5
Fixed assets turnover	4
Current ratio	2
Gross profit margin on sales:	30.00%

Also suppose that Royval Inc has the following balance sheet:

Balance Sheet

Assets	Liabilities
Cash		Current Liabilities
Accounts receivable		Long-term debt	$135,000
Inventories		Common stock
Fixed assets		Retained earnings	$130,000
Total assets	$500,000	Total Liabilities and equity
Sales		Cost of goods sold

According to the video, total assets turnover is equal to . Given the value of total assets turnover, along with the level of total assets given, this means that Royvals sales must be .

According to the video, DSO (days sales outstanding) can be written as . Given the value of DSO, along with the level of sales you already calculated, this means that Royvals recevables must be .

According to the video, the inventory ratio can be written as equal to . Given the value of the inventory ratio, along with the level of sales you already calculated, this means that Royvals inventories must be .

According to the video, the fixed asset turnover ratio can be written as . This means that Royval has fixed assets of .

According to the video, cash can be written as total assets minus fixed assets, inventories, and accounts receivable.

This yields a value of cash of for Royval.

According to the video, the current ratio can be written as . Plugging in the value for current assets and the value of the current ratio yields a value of current liabilities of approximately .

According to the video, the value of total assets is equal to the value of total liabilities and equity.

In the video, total liabilities and equity is equal to . Given the level of total liabilities and equity, as well as retained earnings, current liabilities and the level of long-term debt, solving for Royvals common stock yields .

According to the video, gross profit margin can be written as . Given the gross profit margin and the level of sales you have already calculated, this means that Royval has a cost of goods sold of .

Step 3: Practice: Balance Sheet Analysis

Now its time for you to practice what youve learned.

Suppose that Royval Inc has the following data:

Total assets turnover	1.5
Days sales outstanding	36.5 days
Inventory turnover ratio	5
Fixed assets turnover	4
Current ratio	2
Gross profit margin on sales:	30.00%

Also suppose that Royval Inc has the following balance sheet:

Balance Sheet

Assets	Liabilities
Cash		Current Liabilities
Accounts receivable		Long-term debt	$114,750
Inventories		Common stock
Fixed assets		Retained earnings	$110,500
Total assets	$425,000	Total Liabilities and equity
Sales		Cost of goods sold

Use the formulas you learned about in the previous stage of the problem to answer the following questions.

Given the value of total assets turnover, along with the level of total assets given, this means that Royvals sales must be . Given the value of DSO, along with the level of sales you already calculated, this means that Royvals receivables must be .

Given the value of the inventory ratio, along with the level of sales you already calculated, this means that Royvals inventories must be . Given the value of the fixed assets turnover ratio, as well as the level of sales, this means that Royvals fixed assets must be equal to .

Solving for cash yields a value of cash of for Royval. Given the current ratio of 2 and values of cash, accounts receivable, and inventories, the level of current liabilities must be .

Given the level of retained earnings, current liabilities, and long-term debt, along with the relationship between total assets and total liabilities and equity, this means that Royvals common stock must be .

Given the gross profit margin and the level of sales you have already calculated, this means that Royval has a cost of goods sold of .