Saturday, October 20, 2012

Decoding Balance Sheet

Continuing our this financial statements quest, lets learn more about the Balance sheet(see earlier post here). We should first analyze what is being reported and measured.  Basically there are four primary parameters which are being measured

  • Networth
  • Total Assets
  • Capital tied up in the business (capital employed)
  • Working Capital

The below diagram gives an overview about the balance sheet


Fixed Assets(FA)

Owners Funds(OF)

Long term Liabilities (LTL)

Short Term Assets (STA)

Short Term Liabilities(STL)


Based on the above its now easy to derive the above terms being used ..

Owners Funds (Networth) is a measure of owners funds in the business which includes both the initial seed capital and reserves accumulated as a result of the business output

                                   OF =  FA + STA – (LTL +STL)

So basically it’s a difference between the assets and the liabilities of a business. Its also referred as book value. 

Total Assets is a measure of assets which help the business to succeed as a growing concern. It can be represented either from the asset side or liability side

            TA  = FA + STA     - Based on asset side

          TA = OF+LTL+STL     - Based on liabilities

Capital employed is a measure of long term capital in play in the business. Often the rate of return as a percentage of capital employed to compare investment candidates.It can be represented as

CE = FA+STA- STL   -Based on asset side


CE = OF + LTL - Based on liabilities

Working Capital is a measure of day to day liquidity required for business to function. A real estate business may hold lot of assets however it may not be as liquid as a retail business.

Its represented as




These 4 values are key parameters which should be understood. We will be using these numbers to make sense of the business also these need to be converted into ratios to improve our analysis.