I came across the above Google search query at my site today and I got my topic to write about. Most ask this question and focus on the P&L statement rather than the balance sheet. It is wrong and if you are an experienced person you will know the reason why ? It sounds logical to focus on P&L statement because profit is very important. But that means taking the eye off the ball. A company's annual report of its financial performance consists of a balance sheet, P&L statement and cash flow. All are important. What does a balance sheet indicate and what should you look for in it ?
The most important element in a balance sheet is the debt the company is carrying. This is reflected in the Capital. One component is paid up and fully subscribed and the other component is the borrowings, which is the debt. There is one more element of debt which is known as Sundry Creditors or Bills Payable. Normally, in well managed companies the current assets will be able to meet the current liabilities. That is to put it simply, the current assets should be more than the current liabilities. For the purpose of our discussion, we will ignore the bills payables. Let us get back to debt.
We have what is called as Gearing or Leverage in American parlance. All companies have to borrow to be in business and grow because the interest costs can be met from operating profits and paid back to the lenders like banks. Investors will look for dividends or share appreciation or both. They have to be satisfied. The problem is how much can you borrow without the bottom falling apart. Any company which has a gearing below 70% is a good and safe company, as long as it is making good profits, meeting its obligations and satisfying its stakeholders. It may not be a stock market darling. There are some who operate with a gearing as high as 100%. Anything as high as that is a danger sign. Sure there are some exceptions if you have a steady cash flow like utility companies. Such companies just rotate their customers money like hell. They will just cut off the utility and people have to pay up in time or go without it. Such companies have a gearing higher than 100%. However, not all companies have that luxury and have to wait for their payments from their customers.
The balance sheet gives you an insight on debts the company is carrying. You must remember that profits may be on paper but it is not equal to cash. I must warn that don't get carried away by the P&L statement alone. Look at the balance sheet and cash flow too. The cash flow statement can be very revealing on how the company is managing its finances and whether it is heading for trouble. Hence do not make the mistake of ignoring any component of an annual performance report. All are important and looked at holistically.
© Copyright, Aug 12-08 . Without prejudice. All rights reserved
Balance sheet or profit and loss statement which is better - To learn more about this author, visit Madhavan T Gopalachary's Website.
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Madhavan T Gopalachary
(Visit Madhavan's Website)
Madhavan Gopalachary, nick name "madgopes"
(g pronounced as in go) given by IIT
classmates, is a Mechanical Engineer and
an alumnus of Indian Institute of
Technology, Madras having passed out
specializing in IC Engines &
Thermodynamics.
He has nearly 35 years of experience in
the Corporate World. He started off as a
trainee and handled sales, marketing,
manufacturing, product management, profit
center management, strategic planning and
corporate development including R & D in
various organizations and at various
levels before becoming a CEO. His last two
professional assignments were at CEO level
before embarking to start management
consultancy business on January 01, 1998.
He has worked for British, Swedish MNCs as
well as very large Indian business houses.
He has spent a large portion of his time
from June 1998 till date in East African
Countries practicing as an independent
Management Consultant.
More details can be obtained at the
following web sites:
mmg.name
/mtg.html;
mmgconsu
lting.biz/
Madhavan's articles can be accessed at www.madgopes.com
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