Chapter 2A - The Balance Sheet
 The balance sheet provides a snapshot of the firm’s financial
position on a specific date. It is defined by:
Total Assets = Total Liabilities + Total Shareholder’s Equity
(asset) = (sources of funding)
 Total assets represents the resources owned by the firm.
 Total liabilities represent the total amount of money the firm
owes its creditors.
 Total shareholders’ equity refers to the difference in the value
of the firm’s total assets and the firm’s total liabilities.
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Asset value calculation
 In general, GAAP requires that the firm report assets on its
balance sheet using the historical costs.
 Cash and assets held for sale (such as marketable securities)
are an exception to the rule. These assets are reported using
the lower of their cost or current market value.
 Assets whose value is expected to decline over time (such as
equipment) is reported as “net equipment” which is equal to
the historical cost minus accumulated depreciation.
 The net value reported on balance sheet could be
significantly different from the market value of the asset.
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Assets and liabilities
 Current assets consists of firm’s cash plus other assets the
firm expects to convert to cash within 12 months or less, such
as receivables and inventory.
 Fixed assets are assets that the firm does not expect to sell
within one year. For example, plant and equipment, land.
 Current liabilities represent the amount that the firm owes
to creditors that must be repaid within a period of 12 months
or less such as accounts payable, notes payable.
 Long-term liabilities refer to debt with maturities longer
than a year such as bank loans, bonds.
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The stockholder’s equity
Two components:
1. The amount the company received from selling stock to
investors. It may be shown as common stock in the balance
sheet or it may be divided into two components: par value
and additional paid in capital above par. Par value is the stated
or face value a firm puts on each share of stock. Paid in capital is the
additional amount the firm raised when it sold the shares.
For example, DLK corporation’s par value per share is $2.00 and the firm has 30
million shares outstanding such that the par value of the firm’s common equity is $60
million. If the stocks were issued to investors for $240 million, $180 million represents
paid in capital.
2. The amount of the firm’s retained earnings: the portion of net
income that has been retained (i.e., not paid in dividends) from
prior years operations.
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Firm Liquidity and Net Working Capital
 Liquidity refers to the speed with which the asset can be converted
to cash without loss of value.
 For example, a firm’s bank account is perfectly liquid. Other types
of assets are less liquid as they more difficult to sell and convert to
cash such as PPE (property, plant and equipment).
 For the overall firm, liquidity generally refers to the firm’s ability to
covert its current assets (accounts receivable and inventories) into
cash so that it can pay its bills (current liabilities) on time.
 We can thus measure a firm’s liquidity by computing the net
working capital = current assets – current liabilities.
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Firm Liquidity and Net Working Capital
 If a firm’s net working capital is significantly positive, it is in a
good position to pay its debts on time and is consequently
very liquid.
 Lenders consider the net working capital as an important
indicator of firm’s ability to repay its loans.
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Checkpoint 3.2
Constructing a Balance Sheet
Construct a balance sheet for Gap, Inc. (GPS) using the following list of
jumbled accounts for January 31, 2009. Identify the firm’s total assets and net
working capital:
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Step 4: Analyze
 The firm has invested a total of $7.564M in assets, funded by
$2.158M current liability, $1.019B long-term liability, and
$4.387M owner equity.
 The firm has $4.005M in current assets and $2.158BM in
current liability, leaving the firm with a net working capital of
$4.005-2.158-1.847M.
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Checkpoint 3.2: Check Yourself
Reconstruct the Gap’s balance sheet to reflect the repayment of $1
billion in short-term debt using a like amount of the firm’s cash. What
is the balance for total assets and current liabilities?
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Step 1: Picture the Problem
Current Assets
Cash
Accounts Receivable
Inventories
Other current assets
Total current assets
Current Liabilities
Accounts payable
Short-term debt
Other current liabilities
Total current liabilities
Long-term (fixed) assets
Gross PPE
Less: Accumulated depreciation
Net property, plant and equip.
Long-term Liabilities
Long-term debt
Owner’s Equity
Par value of common stock
Paid-in-capital
Retained earnings
Total equity
Other long-term assets
Total long-term assets
Total Assets
Total Liabilities and
Owners’ equity
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Step 2: Decide on a Solution
Strategy
 We are given the account balances so in order to construct
the balance sheet we need to substitute the appropriate
balances into the template developed in step 1.
 Deduct $1B from both cash and current liability.
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Step 3: Solve
Cash
Inventories
Other current
assets
756,000,000
1,506,000,000
743,000,000
Current liabilities 1,158,000,000
Total current
assets
3,005,000,000
Total current
liabilities
1,158,000,000
Net Property,
Plant and
equipment
2,993,000,000
Long-term
liabilities
1,019,000,000
Other long-term
assets
626,000,000
Common Equity
4,387,000,000
Total Assets
$6,564,000,00 Total Liabilities
0
and Equity
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$6,564,000,00
0
FIN3000, Liuren Wu
Step 4: Analyze
 We can make the following observations from Gap’s
Balance sheet:
 The total assets of $6,564,000,000 is financed by a combination
of current liabilities, long-term liabilities and owner’s equity.
Owner’s equity accounts for $4,387,000,000 of the total.
 The firm has a healthy net working capital of $1,847,000,000
(3,005,000,000 minus 1,158,000,000).
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