MBA Mondays From The Archives: The Balance Sheet
Continuing the visit back in time to the MBA Mondays Archives, today we are going to rerun the post on the Balance Sheet, which is a financial snapshot into the health of your business.
Today on MBA Mondays we are going to talk about the Balance Sheet.
The Balance Sheet shows how much capital you have built up in your business.
If you go back to my post on Accounting, you will recall that there are two kinds of accounts in a company's chart of accounts; revenue and expense accounts and asset and liability accounts.
Last week we talked about the Profit and Loss statement which is a report of the revenue and expense accounts.
The Balance Sheet is a report of the asset and liability accounts. Assets are things you own in your business, like cash, capital equipment, and money that is owed to you for products and services you have delivered to customers. Liabilities are obligations of the business, like bills you have yet to pay, money you have borrowed from a bank or investors.
Here is Google's balance sheet as of 12/31/2009:
Let's start from the top and work our way down.
The top line, cash, is the single most important item on the balance sheet. Cash is the fuel of a business. If you run out of cash, you are in big trouble unless there is a "filling station" nearby that is willing to fund your business. Alan Shugart, founder of Seagate and a few other disk drive companies, famously said "cash is more important than your mother." That's how important cash is and you never want to get into a situation where you run out of it.
The second line, short term investments, is basically additional cash. Most startups won't have this line item on their balance sheet. But when you are Google and are sitting on $24bn of cash and short term investments, it makes sense to invest some of your cash in "short term instruments". Hopefully for Google and its shareholders, these investments are safe, liquid, and are at very minimal risk of loss.
The next line is "accounts receivable". Google calls it "net receivables' because they are netting out money some of their partners owe them. I don't really know why they are doing it that way. But for most companies, this line item is called Accounts Receivable and it is the total amount of money owed to the business for products and services that have been delivered but have not been collected. It's the money your customers owe your business. If this number gets really big relative to revenues (for example if it represents more than three months of revenues) then you know something is wrong with the business. We'll talk more about that in an upcoming post about financial statement analysis.
I'm only going to cover the big line items in this balance sheet. So the next line item to look at is called Total Current Assets. That's the amount of assets that you can turn into cash fairly quickly. It is often considered a measure of the "liquidity of the business."
The next set of assets are "long term assets" that cannot be turned into cash easily. I'll mention three of them. Long Term Investments are probably Google's minority investments in venture stage companies and other such things. The most important long term asset is "Property Plant and Equipment" which is the cost of your capital equipment. For the companies we typically invest in, this number is not large unless they rack their own servers. Google of course does just that and has spent $4.8bn to date (net of depreciation) on its "factory". Depreciation is the annual cost of writing down the value of your property plant and equipment. It appears as a line in the profit and loss statement. The final long term asset I'll mention is Goodwill. This is a hard one to explain. But I'll try. When you purchase a business, like YouTube, for more than it's "book value" you must record the difference as Goodwill. Google has paid up for a bunch of businesses, like YouTube and Doubleclick, and it's Goodwill is a large number, currently $4.9bn. If you think that the value of any of the businesses you have acquired has gone down, you can write off some or all of that Goodwill. That will create a large one time expense on your profit and loss statement.
After cash, I believe the liability section of the balance sheet is the most important section. It shows the businesses' debts. And the other thing that can put you out of business aside from running out of cash is inability to pay your debts. That is called bankruptcy. Of course, running out of cash is one reason you may not be able to pay your debts. But many companies go bankrupt with huge amounts of cash on their books. So it is critical to understand a company's debts.
The main current liabilities are accounts payable and accrued expenses. Since we don't see any accrued expenses on Google's balance sheet I assume they are lumping the two together under accounts payable. They are closely related. Both represent expenses of the business that have yet to be paid. The difference is that accounts payable are for bills the company receives from other businesses. And accrued expenses are accounting entries a company makes in anticipation of being billed. A good example of an accounts payable is a legal bill you have not paid. A good example of an accrued expense is employee benefits that you have not yet been billed for that you accrue for each month.
If you compare Current Liabilities to Current Assets, you'll get a sense of how tight a company is operating. Google's current assets are $29bn and its current liabilities are $2.7bn. It's good to be Google, they are not sweating it. Many of our portfolio companies operate with these numbers close to equal. They are sweating it.
Non current liabilities are mostly long term debt of the business. The amount of debt is interesting for sure. If it is very large compared to the total assets of the business its a reason to be concerned. But its even more important to dig into the term of the long term debt and find out when it is coming due and other important factors. You won't find that on the balance sheet. You'll need to get the footnotes of the financial statements to do that. Again, we'll talk more about that in a future post on financial statement analysis.
The next section of the balance sheet is called Stockholders Equity. This includes two categories of "equity". The first is the amount that equity investors, from VCs to public shareholders, have invested in the business. The second is the amount of earnings that have been retained in the business over the years. I'm not entirely sure how Google breaks out the two on it's balance sheet so we'll just talk about the total for now. Google's total stockholders equity is $36bn. That is also called the "book value" of the business.
The cool thing about a balance sheet is it has to balance out. Total Assets must equal Total Liabilities plus Stockholders Equity. In Google's case, total assets are $40.5bn. Total Liabilities are $4.5bn. If you subtract the liabilities from the assets, you get $36bn, which is the amount of stockholders equity.
We'll talk about cash flow statements next week and the fact that a balance sheet has to balance can be very helpful in analyzing and projecting out the cash flow of a business.
In summary, the Balance Sheet shows the value of all the capital that a business has built up over the years. The most important numbers in it are cash and liabilities. Always pay attention to those numbers. I almost never look at a profit and loss statement without also looking at a balance sheet. They really should be considered together as they are two sides of the same coin.
Loving this stuff, Fred.Do you think the CFO – or equivalent – is involved enough (at an early enough stage to make a difference) in a typical company in our industry?If there’s the budget for a CFO or that type role in a startup I suspect many instead choose to spend on a ‘superstar’ developer or marketeer – or nice new penthouse offices. Do you see that enough nascent companies see the worth in investing in what may appear to be ‘old school’? I am sure in the case of companies in your portfolio that is a given – but, what about elsewhere?
not at the startbut over time, the value of a great CFO is recognized and they are brought in
There’s a natural synergy between finance, operations, infrastructure and at time, human resources.CFO or not, having a financial mind as part of the team building accounting and future revenue systems online is really critical.
Absolutely. I have always really enjoyed involving the finance folk, as early as possible. Am just often amazed how it’s just seen as a ‘necessary evil’ and not really part of the core business. Scary.
Is there a relation between Goodwill and Intellectual Asset?How do we put in value for intellectual asset? OR it is considered ‘Zero’ when we talk about balance sheet? (I mean intellectual asset has no paper value…and it is hidden)?.P.S.I was thinking of writing ” Simply …Where to put the IP value” … i was affraid of getting a reply “Into the Dust-bin” :-).
I don’t read many US balance sheets, but usually it’s goodwill or an intangible — you can probably work out which by perusing the impairment disclosures.
thanx @cammacrae:disqusI think it is easy to put value for IP in privately held company ( and privately held discussion) than in a Public ltd.
Not having crossed this bridge, could I get some clarification on the phrase, “netting out money some of their partners owe them”. Thanks again, Fred. This series continues to confirm how little I actually know about accounting.
Assume one partner owes money to the company, and the same partner is separately owed money for a different transaction with the company. There can be one check written or paid for the net amount.Simple example might beThere is a company that I did some work for……essentially three partners, and one of the partners is more involved with starting the business – re: he coded their original app.The understanding between the three of them was that the partner that did the coding was going to get compensated for doing so, where the other two were not.The three partners equally funded the company, so when it came time to invest additional cash, the partner who did the coding work did not write the same check as the two others. He essentially netted out the $$ he owed the company from the amount that was owed to him for coding.It is always best – paper the transactions properly – so it would be best if the company wrote him a check for the services he did, and in turn he wrote the check to the company for his investment.
Thanks, John. In that scenario, was the “additional cash” from the partners a predetermined amount and recorded on the balance sheet? Do many of you find this to be a common practice?
Additional cash from the partners – essentially they were funding the development of the business. They would periodically ( maybe 3x year) write checks.This might not be common place…although the practice of netting amounts due is more common. think due to / due from partners
Thanks again, John. In other words, get it on the balance sheet. Got it.
Doesn’t this have tax consequences that may or may not be considered? If the partner netted out the money owed him, did he get a 1099 or W-2 on that? Did he gain an advantage because the income he netted wasn’t taxed?If one were strict about the trail, what implication does that have for the fair valuation of the partner’s work. Did he get more if his “pay” was tax-free?
As someone coming from an accounting background & worked as an auditor for several years……..I have always liked the Balance Sheet.You can typically get your hands around it and validate #’s quickly – Cash is Cash, AR you can look at subsequent cash receipts and know that the balance on a certain date was good, PPE – you can look at the changes (additions) that occur year to year….same is true on liabilities side of the ledger – easy to vouch or substantiate balances.There is a saying that if you start with a good balance sheet (beg of yr) and end w/ one at the end of a company’s fiscal year – “the P&L drops out” – i.e. it should equal the change in Retained Earning. This sometime can be a hard concept “to get” some examples – if a companies Y/E Inventory is understated – you increase it w/ a Debit to Inventory (up) – and you Credit the P&L – CGS. If AR is overstated – or not fully collectable you Credit AR (down) or a reserve on the Balance Sheet and Debit an account on the Income Statement (sales or bad debt exp). Same is true for the liabilities side of the ledger – if you need to book an accrual for a medical insurance bill you have not yet received, you Credit accrued expenses and Debit Insurance expense on the P&L (more expense).That’s where the science of accounting comes into play – beside you typically don’t get sued or fired by understating assets, or over stating liabilities.
Yes good comment. You are pointing out the conservative method of accounting (which I like). You can also tell the aggressive method of accounting if the flows are the opposite. I know Fred is going to get into analysis later.The one area I always had a problem with was goodwill. If you’re Google and you’re Price to Book Ratio is 3.57 and you buy a company for PB = 2, why do you have to record half the purchase price in goodwill? In theory you are arbitraging the ratio. Same for P/S. If yours is 5.3 like Google if you could double sales by buying companies at a 3x multiple its almost like printing money. Cisco was a great example of this in the heyday.
Hummm – isn’t it as simple as the Debit (Purchase price paid less assets acquired = GW) Simple Journal entry might be….DR – Assets (cash, ar, inventory)CR – Cash paidDR – GW ( essentially the plug)
The relationship between Current Liabilities and Long-Term Liabilities is an interesting one. I was on the senior management team of a company that had been heavily leveraged via a private-equity takeover (could write a whole book on that experience). So we had lots of long-term debt.Refinancing the debt got more difficult, and eventually we got to the year the long-term debt was coming due. All of a sudden, that amount moved from LT Liabilities to Current Liabilities – and then, compared to our Current Assets (PE-owned companies did not keep a lot of cash on hand, at least back then), it was a huge number. All of a sudden, we were “insolvent,” even though our revenues, profit margins, etc., hadn’t changed.Lesson: long term becomes short term faster than you realize.
It still very common in PE acquired companies and LT Liabilities should be fully disclosed for other shareholders. BTW, great point!
BS can stand for more than the balance sheet, it can also stand for what is within the balance sheet, Lehman , Worldcom, Enron and of course B. Madoff.
truebut if you study the statement of changes in cash flows (next week), you can often detect the BS you speak ofcash flow really doesn’t lie
Special Purpose Entities, off balance sheet maneuvers, used especially by Enron and Lehman are still around.There should be line for Magic.
Has Sarbanes-Oxley had much/any impact?
i think it has had a lot of impact. not all of it positive for innnovation.
There are several fairly straightforward reports that I encourage startups that I work with to get used to running periodically once they hit a certain stage: Recoverable and payable roll forwards and an aging of the recoverables. The roll forwards allow management to see (monthly or quarterly) the regularity of cash coming in to offset the recoverables line of the balance sheet. The payable roll is the opposite – cash being paid out to vendors, etc. The aging (usually on 30 – 90 day increments) gives a snapshot of how long recoverable balances remain outstanding. It also identifies late-paying customers early in a relationship and assists the team in managing revenue expectations.
“Google calls it “net receivables’ because they are netting out money some of their partners owe them. I don’t really know why they are doing it that way. “Could be either:a) allowance for doubtful accountsb) net of money paid to partnersAccording to the nominal definition, it’s “a”http://smallbusiness.findla…Accounts receivable are the amount of money that customerspresently owe the company. Because every company will have some bad debts, theamount of bad debts known and expected should be deducted from the accountsreceivable as “reserve for doubtful accounts. “The net receivables arecalculated as:Accounts Receivable – Reserve For Doubtful Accounts = Net Receivables.Manipulating “a” can be a way a company can fudge their balance sheet. After all, “a” can be entirely subjective.With “b” I’m not talking about strict accounting definition.
“And the other thing that can put you out of business aside from running out of cash is inability to pay your debts.”Tip: If you find yourself in a situation where you are running out of money and can’t pay your debts try and negotiate either extended terms or “cents on the dollar” to reduce money owed to companies. Depending on both the amount, and the company that the money is owed to, you would be surprised what people will accept (decisions are made by people) in order for certainty. Debt not paid is often turned over to collection agencies who get paid a fee to collect. Or it’s written off entirely. Or it’s sold to a third party.
Sometimes best to negotiate a small payment over a ridiculous amount of time. You never know how things might change. And pay a chunk on the credit card, and turn around and use that money to buy groceries if you have to — keeping Uncle Visa happy, and using your money twice.If your medical bill of $20,000 is negotiated down to $20 per month, then you can probably pay the utilities, car payment, and the minimum to keep your mortgage people happy.This is not general advice for employees, but for people who see the realistic potential for a financial change — the house is going to sell, the new job will come through with bonus, Aunt Agatha has named you in the will, the investors will finally come through …
“Google’s current assets are $29bn and its current liabilities are $2.7bn. It’s good to be Google, they are not sweating it.”And as I like to say anytime I see a company that is tremendously profitable, that’s with all the money they are almost certainly pissing away. So that’s what they end up with after all the money they actually spend. And you have to assume they are spending money and have expenses that they can easily cut and still function quite well. That’s how companies get bloated (as well as families) since their spending tends to go in relation to how comfortable they feel at a point in time.
That last sentence about families is especially spot on.
If you’ve not read it already, read ‘Stuff’ by Daniel Miller.
Thanks I haven’t read it.’Stuff’ does have a value. As Capone said “you get more with a gun and a smile then a gun alone” (or something like that). Likewise “stuff”, if it can be “afforded” (the idea of “afford” of course is debatable) does serve a purpose. A nice home (or boat, vacation home etc.), well furnished and in the right neighborhood, allows you to entertain and meet “the right people” at least in the sense of meeting people who could further your goals. Or impress people so they are more motivated to help you out.Dressing well on certain occasions also can help. There are of course always variations to all of this. Dressing down but driving a nice car can have a multiplier effect on people. The list is endless. The bottom line is that people strive for material goods since the beginning of time because it does matter in many cases. (Should be interesting to see the book’s thoughts on this..)There is of course complex interactions with all of this. So there really isn’t any clear generalization that applies in every case.
Absolutely. I haven’t completed the book, yet; has been pretty much read-in-one-sitting attempt, as it is so compelling, but some of it is rather thought-provoking for my little brain, thus requiring some strong coffee, note-taking and re-reading. Love it.http://www.materialworldblo…
Paul Graham has an excellent short essay: http://www.paulgraham.com/s…
I just re-read that. I’m sure I’ve read it in the past. I like his essays.Now, in particular, this:”I’ve now stopped accumulating stuff. Except books—but books aredifferent. Books are more like a fluid than individual objects.It’s not especially inconvenient to own several thousand books,whereas if you owned several thousand random possessions you’d bea local celebrity.”His point about size and portability is significant but I assume he also places an additional value on “books” because he sees them as worthy in some intellectual way. The same way people put education, religion and children in a special category. Almost, in many cases, a third rail.My guess is that a large percentage of the books that anyone owns they never read cover to cover. And they keep them and never throw them out. And while they justify that they learn something and gain knowledge from the books (even fiction) in the end they buy books because reading makes them feel good and the entertainment value. Which is good. We could test this of course by giving someone a book about something that they didn’t particularly enjoy and seeing how far we got. My guess is most people wouldn’t get very far.Regardless of whether companies manipulate you into buying things “you don’t need” I don’t see that as bad in itself. “things” provide enjoyment and pleasure. I don’t enjoy shopping at all, especially for clothes. But many people do and it can be the focus of a complete day of fun for them. All at less of a cost then a 2 hour show in NYC. What’s wrong with that?
When I went to Thailand in the mid-nineties, I had two backpacks: one with clothes and hiking boots, and one with books.I visited Phuket, and, having just read Steinbeck’s Cannery Row, I had a strong sense of the emotional culture of this strange community. I had Somerset Maugham’s The Moon and Sixpence with me — his fictionalized story of Paul Gauguin.When I arrived at Railei Beach, I found an ex-pat Brit who owned a used book store, with his Thai wife, who was eager to take any books I had to trade, and to send me on my way with fresh reading material. He was particularly delighted that I wasn’t just carrying the latest “airport shop” books. My classics were his treasure.I’ve done this on a roadtrip to Alaska, in Mexico, and through many byways across the U.S. I’m always happy to leave behind good reading material — Tony Hillerman, Bryce Courtney, Wilbur Smith, the Bronte sisters, John Grisham, and a host of other writers in many genres.My son rides me because I haven’t yet adopted the Kindle or an iPad as my top choice. But the other day I was waiting in line behind a woman who saw me reading a Jon Land novel (about a female Texas Ranger, JLM!). She commented, “I wish I’d thought to bring a book.” I finished the last three pages and handed the book to her, while I pulled out the next novel in the series. Try that on your iPad!Books are not just things. Books are a medium to hold, and perhaps hand off, a whole world of someone’s careful thoughts, observations and story. The power of the storyteller has kept society connected for millenia. And psychologists say that the human need for entertainment is primal, along with the drives for power, sex, love, and community.Seeing the power of the iPad in so many professional settings, I cannot make light of it and its cousins in any way. But books still work when you’re tucked in a tent waiting out a storm on some remote mountainside, or when you’re bouncing along in a bus far south in the Chihuahua desert, or after the generator shuts off in the Borneo town many miles from the coast. You can carry your storyteller with you, even after the batteries run out.
Did anyone else have the pleasure of seeing that clip of Peter Thiel telling Eric Schmidt point blank that the reason they’re sitting on $30B cash is because they’ve run out of ideas? A pretty bold statement.. but I wish he would do the rounds and say the same thing to other (ex)CEO’s. Get America back to work you hoarders!
“Peter Thiel telling Eric Schmidt point blank that the reason they’re sitting on $30B cash is because they’ve run out of ideas?”As I used to say to my dog when he was chewing on a bone all by himself “it’s no fun by yourself”. (Don’t try and make sense of that btw. the dog certainly didn’t understand what I meant.)If they’ve run out of ideas it’s because they have so much money there is no idea big enough to make a dent and hence all the “garage” fun is out of the process. If you don’t have something to aspire to, life can be pretty depressing. And it’s all relative to what you’ve already done. Look what happen to Phelps after he won all those medals in the 08 olympics. He got all depressed. (60 minutes clip here):http://www.thedailybeast.co…I did a bunch of really nice deals in the first three months of this year. The first thing I said to my wife was “I wish they had been evenly spaced out over the year instead of all in the first three months”. We would go out for date night and it was no longer a surprised when I pulled out emails to show her the play by play of what happened. (See everything suffers!)I can say that there is definitely something to be said for having to do the fight. Fred still has the fight and feels he needs to. That leads to dissonance but also greater happiness. Which is good. My guess is he’d be a wreck if he woke up and just had lunch everyday even if he was mentoring or teaching. Trying to get somewhere and the process of getting there is the fun.What’s Obama going to do after he loses the election (now or in 4 years) at such a young age? Nothing will rise to the level of being President.
What you say about reaching the top is really true. What do they do after that? Really would be frustrating. Many take the route of ‘charity’ ‘serving god by serving people’That is really a good philosophical question …Leave something to achieve (live on) for rest of your life.
Good point, profitability does make companies and families more lax when it comes to their balancing sheets. With companies, for instance, there’s less incentive to really examine processes that waste money but aren’t fully optimized.
http://www.youtube.com/watc… for reference. my initial reaction was “woah… just woah…”. some solid brass!
Kind of apropos… http://tmblr.co/ZlZhLuT7Sa5a
Hear hear!Did they lose their gumption as they accumulated the cash?
Are these principles universal, or would some countries have a problem with some of the accounting techniques described here? Is this a particularly Anglo Saxon approach to bean counting?
Google adheres to the standards FASB (Financial Accounting Standards Board) established, which is used by every publicly traded company here in the States. The accounting industry is self-regulated through this Board and sets its own rules” I can’t speak to other countries.
i don’t know a ton about international accounting but i do know that there has been a lot of effort over the past decade to align all international accounting standards
at 19 i desperately wanted to drop out of UPenn and pursue a BFA at NYU Film School. when i told my father, a successful entrepreneur and my best buddy, he was supportive — it seemed very entrepreneurial to him — but with one big caveat: that i had to take a full year of accounting classes. when i asked him why, he said, “Only a schmuck doesn’t know how to read a balance sheet!”some of the best advice i have ever ever received.(miss you dad)
that’s awesome. i intend to do the same with my son at some point.
We play Robert Kiyosaki’s Cashflow for Kids game and the adult Cashflow to get the kids familiar with the concepts. Works a treat!
I like your dad’s style.
I should keep that in memory for at the least 10-years … my son is about 10 now.thanx @SteveKane:disqus that is one of best thing i got from AVC community. I sure will keep that in memory.
MBA Monday posts get fewer comments than other posts.Why’s that?
that is always truebut it is even more pronounced with these reruns
first time around in 2010 this post got 43 comments, and so this rerun has done quite well to attract 49 comments (49 as I write this 50th comment).To me accounting is to the entrepreneur what structural engineering is to the architect. It’s not at all easy stuff, and ultimately it’s best to leave it to the specialist, but having a working grasp of the fundamentals stops things from collapsing.
yes, but this community has also gotten more active in those two years
trueI’m thinking Boomtown Ratshttp://www.youtube.com/watc…
I’m loving the refresher. I’m sure it’s more a matter of a lot more listening than talking. And what little has been said is good.
I’m guessing MBA Mondays get fewer comments because the information is so “black and white.” People don’t want to challenge what they may not already understand in-depth. And they don’t realize that there are many tangents to this B&W info.Really, this information is so vital. Like being able to balance a checkbook is significant the minute you open your checking account. Even if you no longer use checks. (Or perhaps even more important if you don’t carry checks!)And discussions about how this information is core, and how it can also be manipulated, should be part of the education of every entrepreneur. Those with integrity can watch out for the manipulations.