Financial Analysis of Balance Sheet
CFO Superior Living Cc: CEO From: Miranda Bergen, VP of Finance Date: October 17, 2011 Subject: Financial Analysis of Balance Sheet Good afternoon, I would like to thank you for taking the time to review my analysis of our balance sheet. As the vice president of finance it is my responsibility to analyze all financial documents and to maintain a close eye on our finances. I have been asked to analyze the balance sheet and explain my findings concerning the working capital, current ration, and the short- and long-term debts.
A balance sheet analysis is focused mainly on determining whether our company is financially stable and strong and economically efficient (Kennon, n. d. ). Working Capital My first task is to explain our working capital. Our working capital is a figure that is calculated in order to determine how much of our liquid assets will be available for our day-to-day use towards expenses (expected and unexpected), short-term debt, to help build the business, and for capital projects (Wolfe, n. d. ).
The calculation that will be utilized to determine our working capital, one must use that accounting formula: Current Assets – Current Liabilities = Working Capital (Kennon, n. d. ). (in thousands)| 2001| 2002| 2003| Current Assets| 73,700| 79,200| 83,900| Current Liabilities| 34,200| 37,100| 41,950| Working Capital| 39,500| 42,100| 41,950| (CTU Online, 2011). This chart tells us that the working capital in 2001 was $39,500,000, 2002 it was $42,100,000, and in 2003 it was $41,950,000. This means that Superior Living, Inc. (SLI) has $42 billion in working capital.
Looking at SLI’s working capital for these three years it is clear that our company was completely capable of paying off our current liabilities. Our company having a positive working capital portrays that we are financially healthy and stable, had any of the results been negative then our company would not be capable of meeting the short-term debt/current liabilities obligation (Kennon, n. d. ). Current Ratio My second task was to calculate the current ratio (CR) for SLI. The current ratio is utilized by financial institutions that may be in the position of offering credit or loans to SLI.
The CR is calculated to determine whether our company will be capable of paying off our obligations when they come due. The balance sheet is the major financial statement utilized to determine what the CR is (Ford, 2010). The following equation will reflect what the CR is: Current Assets/Current Liabilities = Current Ratio (in thousands)| 2001| 2002| 2003| Current Assets| 73,700/| 79,200/| 83,900/| Current Liabilities| 34,200| 37,100| 41,950| Current Ration| 2. 2| 2. 1| 2| (CTU Online, 2011). The “good” CR should be at least 1. 5 and not more than 3 or 4.
The CR will vary from industry to industry and business to business (Ford, 2010). Ford (2010) stated that it is harder to obtain short-term financing if the CR is below 2. Banks are very reluctant to provide funds to companies with a cash flow problem because banks do not like to “force the liquidation of a company” (Ford, 2010). It is also not good to have a CR that is too high, according to Kennon (2010) because this is a sign that our management is not adequately using our cash. The results in the chart above displays that our company has had a “good” CR” for each of these three years, having a CR of 2. in 2001, a 2. 1 in 2002, and a 2 in 2003. According to our CR ratio, our company is in good standing to obtain short-term financing. This short-term financing is what our company uses to fund our “day-to-day expenses” so maintaining a “good” CR is very important for SLI. Short-Term Debt Our short-term debts, also known as current liabilities, are the debts that our company has accumulated that are expected to be paid off within a year. The short-term debts of our company are listed as our current portion of long-term debt, accounts payable, and other current liabilities (Marshall, n. d. ).
Within our current liabilities, we have our current portion of long-term debt, sometimes known as notes payable (Marshall, n. d. ). These notes are one of the most important factors under this section because they are bank loan payments that are due within the year. We also have accounts payable in this section, which is the commonly the largest, this account is used for ordering new products and paying suppliers for services and products (Kennon, n. d. ). The final factors listed in this section are the other current liabilities. Most of these expenses will be listed in the annual report or the 10K.
Chart of Total Current Liabilities (in thousands)| 2001| 2002| 2003| Current Portion of Long-Term Debt| 1,200| 1,300| 1,450| Accounts Payable| 27,000| 29,500| 33,000| Other Current Liabilities| 6,000| 6,300| 7,500| Total Current Liabilities| 34,200| 37,100| 41,950| (CTU Online, 2011). Long-Term Liabilities Now let us focus on the long-term liabilities. When we speak of long-term liabilities we are talking about the continued liabilities of our company. These liabilities are the funds that our company owes but does not expect to pay off within the year (Kennon, 2011).
The long-term liabilities that are listed on our balance sheet are long-term debt and other long-term liabilities. These expenses could be big ticket items such as mortgages to pay for the purchase or leasing of a building, any pensions that were promised to former employees, the purchase of equipment or assets that will be beneficial to the company in the future (Kennon, 2011). A decreasing amount in long-term debt is a sign that the company is prospering, financially health and getting healthier. A balance sheet that is showing a decreasing debt is said to be “improving” (Kennon, 2011).
However, if the balance statement shows an increase in long-term debt then it is said to be “deteriorating” (Kennon, 2011). Too much long-term debt can result in very high interest payments, not enough working capital or at worst case, bankruptcy. Chart of Total Liabilities (in thousands)| 2001| 2002| 2003| Long-Term Debt| 3,000| 3,100| 3,400| Other Long-Term Debt| 5,000| 6,000| 7,000| Total Liabilities| 42,200| 46,200| 52,350| Conclusion The balance sheet is one of the most critical financial statements that a company possesses.
Analysis of a balance sheet will determine the financial health of a company. This analysis can tell management many important details about our company’s finances. It also displays what our company owns and what we owe out. To focus on the concerns of the CFO: * The working capital of SLI has proven to be clearly capable of paying off our current liabilities and that our company is financially strong and healthy. It also displays that our company will continue to be healthy as long as we maintain a working capital that is sufficient enough to cover our future liabilities. The impact of our short-term debts will not decrease our company’s ability to prosper as long as we do not acquire short-term debt that will exceed our working capital. * Our current ratio for these three years is considered to be a “good” ratio. We will remain in good standing as long as our liabilities do not exceed our assets. * How to finance the construction of a new production plant is a huge concern for not only the CFO but for all members of management. There are many different avenues to take when it comes to funding major capital projects.