Module 3 Fundamental Analysis

Chapter 7

Understanding the Balance Sheet Statement (Part 2)

36

7.1 – The Assets side of Balance Sheet

In the previous chapter we looked at the liability side of the balance sheet in detail. We will now proceed to understand the 2nd half of the balance sheet i.e the Asset side of the balance sheet. The Asset side shows us all the assets the company owns (in different forms) right from its inception. Assets in simple terms are the resources held by a company, which help in generating the revenues. Here is the snapshot of the Assets side of the balance sheet:

M3-Ch7-Chart1

As you can see the Asset side has two main sections i.e Non-current assets and Current assets. Both these sections have several line items (with associated notes) included within. We will look into each one of these line items.

M3-Ch7-title1

7.2 – Non-current assets (Fixed Assets)

Similar to what we learnt in the previous chapter, non-current assets talks about the assets that the company owns, the economic benefit of which is enjoyed over a long period (beyond 365 days). Remember an asset owned by a company is expected to give the company an economic benefit over its useful life.

If you notice within the non-current assets there is a subsection called “Fixed Assets” with many line items under it. Fixed assets are assets (both tangible and intangible) that the company owns which cannot be converted to cash easily or which cannot be liquidated easily. Typical examples of fixed assets are land, plant and machinery, vehicles, building etc. Intangible assets are also considered fixed assets because they benefit companies over a long period of time. If you see, all the line items within fixed assets have a common note, numbered 10, which we will explore in great detail shortly.

Here is the snapshot of fixed assets of Amara Raja Batteries Limited:

M3-Ch7-Chart2

The first line item ‘Tangible Assets’ is valued at Rs.619.8Crs. Tangible assets consists of assets which has a physical form. In other words these assets can be seen or touched. This usually includes plant and machinery, vehicles, buildings, fixtures etc.

Likewise the next line item reports the value of Intangible assets valued at Rs.3.2 Crs. Intangible assets are assets which have an economic value, but do not have a physical nature. This usually includes patents, copyrights, trademarks, designs etc.

Remember when we discussed the P&L statement we discussed depreciation. Depreciation is a way of spreading the cost of acquiring the asset over its useful life. The value of the assets deplete over time, as the assets lose their productive capacity due to obsolescence and physical wear and tear. This value is called the Depreciation expense, which is shown in the Profit and Loss account and the Balance Sheet.

All the assets should be depreciated over its useful life. Keeping this in perspective, when the company acquires an asset it is called the ‘Gross Block’. Depreciation should be deducted from the Gross block, after which we can arrive at the ‘Net Block’.

Net Block = Gross Block –Accumulated Depreciation

Note, the term ‘Accumulated’ is used to indicate all the depreciation value since the incorporation of the company.

When we read tangible assets at Rs.619.8 Crs and Intangible assets at Rs.3.2 Crs, do remember the company is reporting its Net block, which is Net of Accumulated depreciation. Have a look at the Note 10, which is associated with fixed assets.

M3-Ch7-Chart3

At the top of the note you can see the Gross Block, Depreciation/amortization, and Net block being highlighted. I have also highlighted two net block numbers which tallies with what was mentioned in the balance sheet.

Let us look at a few more interesting aspects on this note. Notice under Tangible assets you can see the list of all the assets the company owns.

M3-Ch7-Chart4

For example, the company has listed ‘Buildings’ as one of its tangible asset. I have highlighted this part:-

M3-Ch7-Chart5

As of 31st March 2013 (FY13) ARBL reported the value of the building at Rs.93.4 Crs. During the FY14 the company added Rs.85.8Crs worth of building, this amount is classified as ‘additions during the year’. Further they also wound up 0.668 Crs worth of building; this amount is classified as ‘deductions during the year’. Hence the current year value of the building would be:

Previous year’s value of building + addition during this year – deduction during the year

93.4 + 85.8 – 0.668

= 178.5Crs

You can notice this number being highlighted in blue in the above image. Do remember this is the gross block of the building. From the gross block one needs to deduct the accumulated depreciation to arrive at the ‘Net Block’. In the snapshot below, I have highlighted the depreciation section belonging to the ‘Building’.

M3-Ch7-Chart6

As of 31st March 2013 (FY13) ARBL has depreciated Rs.17.2 Crs, to which they need to add Rs.2.8 Crs belonging to the year FY14, adjust 0.376 Crs as the deduction for the year. Thus, the Total Depreciation for the year is:-

Previous year’s depreciation value + Current year’s depreciation – Deduction for the year

= 17.2 + 2.8 – 0.376

Total Depreciation= Rs.19.736 Crs. This is highlighted in red in the image above.

So, we have building gross block at Rs.178.6 Crs and depreciation at Rs.19.73 Crs which gives us a net block of Rs.158.8 Crs ( 178.6– 19.73). The same has been highlighted in the image below:

M3-Ch7-Chart7

The same exercise is carried out for all the other tangible and intangible assets to arrive at the Total Net block number.

The next two line items under the fixed assets are Capital work in progress (CWIP) and Intangible assets under development.

CWIP includes building under construction, machinery under assembly etc at the time of preparing the balance sheet. Hence it is aptly called the “Capital Work in Progress”. This amount is usually mentioned in the Net block section. CWIP is the work that is not yet complete but where a capital expenditure has already been incurred. As we can see, ARBL has Rs.144.3 Crs under CWIP. Once the construction process is done and the asset is put to use, the asset is moved to tangible assets (under fixed assets) from CWIP.

The last line item is ‘Intangible assets under development’. This is similar to CWIP but for intangible assets. The work in process could be patent filing, copyright filing, brand development etc. This is at a miniscule cost of 0.3 Crs for ARBL. All these costs are added to arrive at the total fixed cost of the company.

7.3 – Non-current assets (Other line items)

Besides the fixed assets under the non-current assets, there are other line items as well. Here is a snapshot for the same:

M3-Ch7-Chart8

Non-current investments are investments made by ARBL with a long term perspective. This stands at Rs.16.07 Crs. The investment could be anything – buying listed equity shares, minority stake in other companies, debentures, mutual funds etc. Here is the partial (as I could not fit the entire image) snapshot of Note 11. This should give you a perspective.

M3-Ch7-Chart9

The next line item is long term loans and advances which stand at Rs.56.7Crs. These are loans and advances given out by the company to other group companies, employees, suppliers, vendors etc.

The last line item under the Non-current assets is ‘Other Non-current assets’ which is at Rs. 0.122 Crs. This includes other miscellaneous long term assets.

M3-Ch7-title2

7.4 – Current assets

Current assets are assets that can be easily converted to cash and the company foresees a situation of consuming these assets within 365 days. Current assets are the assets that a company uses to fund its day to day operations and ongoing expenses.

The most common current assets are cash and cash equivalents, inventories, receivables, short term loans and advances and sundry debtors.

Here is the snapshot of the current assets of ARBL:

M3-Ch7-Chart10

The first line item on the Current assets is Inventory which stands at Rs.335.0 Crs. Inventory includes all the finished goods manufactured by the company, raw materials in stock, goods that are manufactured incompletely etc. Inventories are goods at various stages of production and hence have not been sold. When any product is manufactured in a company it goes through various processes from raw material, to work in progress to a finished good. Snapshot of Note 14 associated with inventory of the company is as shown below:

M3-Ch7-Chart11

As you can see, a bulk of the inventory value comes from ‘Raw material’ and ‘Work-in- progress’.

The next line item is ‘Trade Receivables’ also referred to as ‘Accounts Receivables’. This represents the amount of money that the company is expected to receive from its distributors, customers and other related parties. The trade receivable for ARBL stands at Rs.452.7 Crs.

The next line item is the Cash and Cash equivalents, which are considered the most liquid assets found in the Balance sheet of any company. Cash comprises of cash on hand and cash on demand. Cash equivalents are short term, highly liquid investments which has a maturity date of less than three months from its acquisition date. This stands at Rs.294.5 Crs. Note 16 associated with Cash and bank balances is as shown below. As you can see the company has cash parked in various types of accounts.

M3-Ch7-Chart12

The next line item is short-term loans and advances, that the company has tendered and which is expected to be repaid back to the company within 365 days. It includes various items such as advances to suppliers, loans to customers, loans to employees, advance tax payments (income tax, wealth tax) etc. This stands at Rs.211.9 Crs. Following this, is the last line item on the Assets side and infact on the Balance sheet itself. This is the ‘Other current assets’ which are not considered important, hence termed ‘Other’. This stands at Rs.4.3 Crs.

To sum up, the Total Assets of the company would now be:-

Fixed Assets + Current Assets

= Rs.840.831 Crs + Rs.1298.61 Crs

= Rs. 2139.441 Crs, which is exactly equal to the liabilities of the company.

With this we have now run through the entire Assets side of the Balance sheet, and infact the whole of Balance sheet itself. Let us relook at the balance sheet in its entirety:

M3-Ch7-Chart13

As you can see in the above, the balance sheet equation holds true for ARBL’s balance sheet,

Asset = Shareholders’ Funds + Liabilities

Do remember, over the last few chapters we have only inspected the balance sheet and the P&L statements. However, we have not analyzed the data to infer if the numbers are good or bad. We will do the same when we look into the financial ratio analysis chapter.

In the next chapter, we will look into the last financial statement which is the cash flow statement. However, before we conclude this chapter we must look into the many ways the Balance sheet and the P&L statement are interconnected.

7.5 – Connecting the P&L and Balance Sheet

Let us now focus on the Balance Sheet and the P&L statement and the multiple ways they are connected (or affect) to each other.

Have a look at the following image:

M3-Ch7-Chart14

In the image above, on the left hand side we have the line items on a typical standard P&L statement. Corresponding to that on the right hand side we have some of the standard Balance Sheet items. From the previous chapters, you already know what each of these line items mean. However, we will now understand how the line items in the P&L and the Balance Sheet are connected to each other.

To begin with, consider the Revenue from Sales. When a company makes a sale it incurs expenses. For example if the company undertakes an advertisement campaign to spread awareness about its products, then naturally the company has to spend cash on the campaign. The money spent tends to decrease the cash balance. Also, if the company makes a sale on credit, the Receivables (Accounts Receivables) go higher.

Operating expenses includes purchase of raw material, finished goods and other similar expenses. When a company incurs these expenses, to manufacture goods two things happen. One, if the purchase is on credit (which invariably is) then the Trade payables (accounts payable) go higher. Two, the Inventory level also gets affected. Whether the inventory value is high or low, depends on how much time the company needs to sell its products.

When companies purchase Tangible assets or invest in Brand building exercises (Intangible assets) the company spreads the purchase value of the asset over the economic useful life of the asset. This tends to increase the depreciation mentioned in the Balance sheet. Do remember the Balance sheet is prepared on a flow basis, hence the Depreciation in balance sheet is accumulated year on year. Please note, Depreciation in Balance sheet is referred to as the Accumulated depreciation.

Other income includes monies received in the form of interest income, sale of subsidiary companies, rental income etc. Hence, when companies undertake investment activities, the other incomes tend to get affected.

As and when the company undertakes Debt (it could be short term or long term), the company obviously spends money towards financing the debt. The money that goes towards financing the debt is called the Finance Cost/Borrowing Cost. Hence, when debt increases the finance cost also increases and vice versa.

Finally, as you may recall the Profit after tax (PAT) adds to the surplus of the company which is a part of the Shareholders equity.


Key takeaways from this chapter

  1. The Assets side of the Balance sheet displays all the assets the company owns
  2. Assets are expected to give an economic benefit during its useful life
  3. Assets are classified as Non-current and Current asset
  4. The useful life of Non-current assets is expected to last beyond 365 days or 12 months
  5. Current assets are expected to payoff within 365 days or 12 months
  6. Assets inclusive of depreciation are called the ‘Gross Block’
  7. Net Block = Gross Block – Accumulated Depreciation
  8. The sum of all assets should equal the sum of all liabilities. Only then the Balance sheet is said to have balanced.
  9. The Balance sheet and P&L statement are inseparable. They are connected to each other in many ways.

36 comments

  1. Savi Suri says:

    Sir i am actually going to ask something out of topic .
    I was going through the annual reports of torrent pharma . I calculted some ratios , and roe was good , its above 25% . Can you tell me about torrent pharma’s other ratios . why its debt is rising , Its consolidated profit is less than its standalone profit .
    I want to ask , is it a good stock for investment .

    • Karthik Rangappa says:

      ROE can be good but if it comes at the cost of excessive financial leverage then it may not be that impressive. Suggest you break down ROE in terms of DuPont analysis and check once. To understand why debt is raising etc I would suggest you read the AR. I’m certain the management has given an explanation there.

  2. Dr Shivanand says:

    simple, easily explained for a person from non-financial field. Good job.Thanks a lot.keep it up sir.

  3. praneeth menduI says:

    Hi,
    Really amazing content. my question is there is a deduction of 0.668 cr under the example cited here i.e buildings. Does this mean it is sold off? if yes then where is this amt added?

    Also i would like to mention a few suggestions only because i like your work so much and it would mean a lot to contribute:

    1) Not on this topic but earlier ones used to contain a lot of comments. That’s a good thing as they contain little bits and examples that cant be contained in the chapter but i wish there was some liking( or +1 ) kind of feature or curation from your side to make the best ones come first or appear larger or whatever. Basically some ranking kind of thing to rank the best interactions without having to read every comment. And a lot of people ask doubts too early in the wrong chapter i hope u c
    an create a provision to move those from your side.
    2) The share button is very distracting and obstructs the text sometimes. If you just allign it to the right I think it would greatly reduce the problem.
    3) Its amazing that you don’t have any banners and adds on this site but this works against u in one aspect that is its much easier to read a body of text that has 7 – 10 words per line (a pretty standard rule of calligraphy).

    • Karthik Rangappa says:

      Thank you so much for the suggestions Praneeth!

      The 0.668 Crs has been written off the books of account and is no longer considered as assets, hence it would not be added to any other part of the Balance sheet.

      The ranking idea for comments is good, I will check internally if this is implementable by us.
      Will try and lighten out the share button, so that it is less distracting….and also thanks for the tip on calligraphy method, I will try and incorporate it.

      Please do continue to share more inputs so that we can turn this into a meaningful resource.

  4. Nishant Jain says:

    Your work helped me to form a base for understanding the statements and balance sheet however i want deeper insights to understand companies fundamentals. I Request you to provide me some books to get advanced knowledge for the same.
    Thank you

  5. Shashank says:

    Sir i am truely impressed by your work…It was very useful to me. Hope you keeod doing the good work. One more important thing that this webpage has no advertisements at all. It was a good experience learning hear.

  6. SAILAJA says:

    What a fantastic module on P&L stmt and Balance sheet, which is written in way it can be easily understood by any retail investor. Hat’s off to you Karthik sir and ZERODHA. This is what called passing value to customers (in fact to anybody as you have made it as open source). And this is one of the reason ZERODHA is distinctly different from other discount brokers and from many traditional brokers as well. Once again well done and am happy that i am a customer of ZERODHA.

  7. Kashif says:

    Thanks Zerodha for sharing this wonderful knowledge …..
    I appreciate your handwork . I have Question …
    In balance sheet, the net profit is added in reserve and surplus ( liability side ) .Consider if the company AAA make profit 200 cr without change in Asset ,then How they will maintain balance sheet equation ” Asset = liability “

    • Karthik Rangappa says:

      Well, I suppose it gets balanced out with other assets – inventory, Capital work in progress, receivables etc.

  8. lakshminadharao says:

    i have finally getting the answers for my doubts remained after spending no of months of time on internet searching for useful material for doubts of balance sheet and other financial statements. i am thankful to you. but here my doubt is how can we get related information related to each item as you explained in the this article?

    • Karthik Rangappa says:

      Usually the Annual report of the company has all the narrations wrt to the line items in the Financial statements.

  9. Victor Ganguly says:

    Hi Karthik,
    I really appreciate your nuanced explanation about balance sheet. Great work. Just as I dwelled deeper, I came across many more things in Moneycontrol, so if you go their website, in balance sheet section of any company. Taking here the example of AmaraRaja Batteries, can you explain the Other information part, containing CIF value of Imports and The FOB VALUE of goods. In fact the whole part under the section of Additional Information. And how and where these values have been incorporated?
    Thanks in advance.
    Victor

    • Karthik Rangappa says:

      Generally all these would be included under one main header in the balance sheet. Suggest you read through the notes of the company for a quick narration of the line item.

  10. Vaibhav Sinha says:

    Why the depreciation in Balance sheet is different than the depreciation in P&L Statement?
    in P&L Sheet its 645.71 & IN Balance Sheet it is 647.2

    • Karthik Rangappa says:

      This is the way it would work, assume a new company starts today –

      Year 1 depreciation = 10 Crs

      For this year in both P&L and BS depreciation amt would be 10Crs

      Year 2 depreciation = 5 Crs

      For Year 2 P&L depreciation would be 5 Crs and BS depreciation amt would be 10 + 5 = 15 Crs

      So P&L gives yearly data…and BS gives you accumulated data.

  11. John says:

    Thanks a lot for sharing this vital information with everyone, you are doing a wonderful work by educating people about market which makes people aware about the market and once again thanks a lot.

  12. Kris says:

    Hello Karthik,

    I just did a DCF valuation using your excel on Asian Paint stock and the lower & upper intrinsic values(considering 15% error leeway) came to Rs. 425 and Rs. 575 respectively. However the current stock price of Asian Paint is Rs. 1160 – almost double the price of upper intrinsic value.
    I am confident that my inputs to the excel are fairly correct, so why there is so much price gap? I am holding 100 shares of it at an average price of Rs. 1157 – so if my DCF calculation is correct I should be selling it immediately – isn’t it? Also I find in the news that few analyst are predicting the stock price to go up to Rs. 1230 – so I am confused what to consider here.

  13. shri31565 says:

    Hello Karthik,
    Since I have Invested in Syndicate Bank, I Just want to study Bank’s financial statement , as Bank’s Financial statement is different from any other company’s statement, Is there any website wherein I can get detailed study of Bank’s , since it a service sector, the balance sheet is different any other company

    • Karthik Rangappa says:

      I agree, and I must confess I’m not really good at reading the financial statement;s of banks. Also, I’m not sure from where you can understand this.

  14. shri31565 says:

    I find it difficult to believe it, that you are not good at reading the financial statement’s of bank, I hope your reply is not sarcastic one.

  15. Akash says:

    “Further they also wound up 0.668 Crs worth of building;” What do you mean by this statement?

  16. Ram says:

    Hi Karthik!
    I ‘m not entirely sure of the difference between P and L statement, and Balance statement. Is the difference just in that the PL statement gives yearly data while Balance statement gives consolidated data?

    • Karthik Rangappa says:

      P&L reports the profit or loss made during the year. Balance sheet, on the other hand, reports various other financial metrics of the company like – debt, net worth, share holders wealth, fixed assets etc. I’d suggest you go through these chapters in detail to get a sense of whats happening with these two statements.

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