Value Investors Tribe

Understanding business of any kind requires understanding its financials which requires understanding accounting basics. In this series of blogs focused on accounting basics, we will try to understand accounting principles required to decode financials of a business. In the previous blogs we understood the basics of income statement and from this section, we explore the balance sheet.

This is part 2 of decoding balance sheets and as customary, we’ll discuss five line items of the balance sheet, continued from part 1. Five line items from the balance sheet are explained below:

• Net Receivables: When a business sells its goods, sometimes it’s sold on credit i.e., the payment for the goods sold will be completed later in time. This amount which purchaser owes to the business is recorded as net receivables.
• Prepaid Expenses: Prepaid expenses is opposite of net receivables. Sometimes businesses pay for equipment, goods or services in advance which they are yet to receive in future. This is recorded under prepaid expenses.
• Other Current Assets: Other current assets are non-cash assets that are due within the year but are not yet in the company’s hands. This includes things such as deferred income tax recoveries.
• Property, Plant and Equipment: As the name indicates, this is the total value of all the properties, land, plants, equipments and other similar things which the business owns. They are recorded at their original cost less accumulated depreciation.
• Goodwill: Goodwill is the computed value of intangible assets of a company the business acquired. This can be the value of brand, culture, trademark or other similar intangible asset which the acquired company owns. Warren Buffett has written a very interesting piece on how to account for Goodwill in his 1983 letter to shareholders, interested readers can glance through it. It’s a great read!

Action Items:

• Dig through the balance sheet of your favorite company and see what these line items look like.
• Dig through the balance sheet of the businesses we analyzed and see if you see a pattern in it!
• Do you see any correlation between numbers in income statement and balance sheet?
• What are the key points Buffett discussed in his note on Goodwill?