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0:01
How to analyze a balance sheet? Let me show you in this balance sheet tutorial covering Apple Inc.
0:07
Balance sheet numbers lead to insights on how a company works. Line item details, category totals, financial ratios, all of these give you the building blocks to your balance sheet insights. Whatever part of the balance sheet you are looking at, constantly ask yourself “What is going on here?”, “What is happening on this balance sheet, and how does it compare to what I expected to see?”. Let me show you in this balance sheet tutorial what generic and
0:35
specific questions to ask. Once you have done your analysis of a balance sheet section, it’s useful to decide on the importance of what you have found: did you come up with a major insight, or something that is good to know but not really a breakthrough, or merely a piece of balance sheet trivia that might soon be forgotten? In that order of importance. Sometimes, combining several pieces of trivia can lead to something that is good to know. And combining several things that
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are good to know can lead to major insights. You will only find this out after the fact.
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So what kind of major insights about Apple Inc will we cover in this balance sheet analysis tutorial? What will we have found at the end of the road?
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First of all: equity on the balance sheet has eroded from $134B to $51B over the past years.
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Second: “Net cash and marketable securities” is $49B, which is a product of a lot of line items in assets minus a lot of line items in liabilities. And third: working capital at fiscal year-end is ($6.2B). All of that might be a bit cryptic for you at this point. I will show you what each of these balance sheet insights mean, and how I arrived at them.
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But first, let’s calibrate on what a balance sheet is, and how it works. The balance sheet is an overview what a company owns and what a company owes at a point in time.
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What is owned is on the left, what is owed is on the right. You could see the balance sheet as a snapshot, a picture, of the financial health of a company.
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Often, you need to take a quick look at other financial statements to fully understand the balance sheet. The income statement focuses on how much a company has earned, while the cash flow statement focuses on the sources and uses of cash. Both of these cover the flow during a certain period (usually a quarter, or a year), so they are like a movie.
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When reading a balance sheet, start off at the highest level: by category. Current assets and non-current assets on the left. Current liabilities, non-current liabilities, and equity on the right.
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Current assets are cash and other assets that are expected to be converted to cash within a year.
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Non-current assets are longer-term investments that cannot be converted into cash quickly.
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Current liabilities are amounts due to be paid to creditors within twelve months. Non-current liabilities are amounts owed that are to be paid after the period of one year.
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Equity on the balance sheet is the book value of the shareholder capital.
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That’s how the balance sheet works on a conceptual level. Let’s now look into the balance sheet of a real-world company called Apple at the end of its fiscal year 2022. Current assets $135.4 billion, non-current assets $217.4 billion, adding up to total assets of $352.8 billion.
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Current liabilities $154 billion, non-current liabilities $148.1 billion, equity $50.7 billion. And as the word balance sheet suggests, the total amount owned (on the left) equals the total amount owed (on the right). Both sides of the balance sheet sum to $352.8 billion. Per the accounting equation: assets equal liabilities plus equity.
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Two calculations immediately jump to mind here, to start getting a grip on what is happening on this balance sheet. First one: a liquidity ratio called the current ratio, which is calculated by dividing current assets by current liabilities. $135.4B divided by $154B.
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Outcome: a current ratio of 0.9. What does that tell us? A current ratio of 1 means that every $ of current liabilities is covered by a $ of current assets. So a current ratio of 0.9 means that every $ of current liabilities is not fully covered, as there are only 90 cents of current assets against it. A current ratio of 1 is quite a common outcome for a well-established company. However, a lot of tech companies have a current ratio far exceeding 1, as they have accumulated
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a lot of wealth on their balance sheet over the years. Why is Apple’s current ratio only 0.9? I am not really worried about Apple’s ability to pay its short term debts. My initial thoughts are that there is probably strong working capital management at Apple, or other company specific factors, that drive this. We can find out whether that’s the case once we look at line item detail rather than category totals on the balance sheet.
5:45
Second calculation on this aggregated balance sheet level: the debt-to-equity ratio, a measure of solvency. At this point in the balance sheet analysis, we define debt as total liabilities, we can get more sophisticated later on. Debt-to-equity for Apple is $302.1B of liabilities divided by $50.7B of equity, which is a 6-to-1 ratio. 6 to 1. What is going on here? Apple is a highly successful company, that is raking in billions and billions of dollars in
6:22
profit per year. How come their balance sheet is so highly leveraged? Or more specifically: how come the equity on the balance sheet is so low? The income statement tells us that in the latest financial year, revenue of $394B generated a net income of $100B. When a company is profitable, its equity normally grows year over year, as the net income from the income statement gets added to retained earnings (which is part of equity) on the balance sheet. How come that is not happening
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at Apple? Something we will find out in a deeper dive of the equity section of the balance sheet.
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Time to zoom into the balance sheet in more detail…
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We will review what is in each of the balance sheet categories:
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current assets, non-current assets, current liabilities, non-current liabilities, and equity. Same five categories, just a lot more detail to dig into.
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In the American format of the balance sheet, assets are listed from most liquid at the top to least liquid at the bottom. Liabilities are listed from due first to due last.
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Let’s start at the top left: cash and cash equivalents of $23.6B.
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What’s the question that immediately jumps to mind?
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How much of this is cash, and how much is cash equivalents? The notes to the financial statements in the 10-K annual report are of great help here, specifically note 3 on financial instruments. Before we go there, let’s define cash equivalents: highly liquid investments that are readily convertible into cash with original maturities of three months or less when purchased. In other words, very close to cash, but not quite there yet.
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Here’s the $23.6B from the balance sheet shown by component. Cash is $18.5B, money market funds $2.9B, certificates of deposits and time deposits $1.8B. That’s what makes up the bulk of it. By itself, this is an insight that falls into the “good to know” category, but we will be able to combine it with other insights to come up with a major insight!
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Here's a line item closely related to cash and cash equivalents: marketable securities of $24.7B.
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What are marketable securities? Marketable securities consist of securities with original maturities greater than 90 days when purchased. So cash equivalents are three months or less, and marketable securities greater than 90 days.
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Securities, in turn, are financial instruments that have monetary value and can be traded. If you review the detailed list, you find out that Apple has mostly invested in corporate debt securities (of other companies), non-US government securities, and US Treasury securities.
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When you look down the list of assets on the balance sheet, you don’t just find marketable securities in current assets (expected to be converted to cash within a year), but also in non-current assets. Actually, a far bigger number of $120.8B of marketable securities is in non-current assets, in other words with maturities of more than one year.
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What are the top items in terms of $ size? Corporate debt securities of $70B,
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mortgage- and asset-backed securities of $20B, and US Treasury securities of $18B. Huge numbers. Apple is not just a maker of gadgets, but in my opinion also a massive hedge fund.
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All three balance sheet line items we have looked at so far on the left have a detailed list in the table on the right. Zooming out to the bigger picture: the sum of cash and cash equivalents, current marketable securities and non-current marketable securities is $169.1B (or 48% of total assets). That’s a stunningly large number, both in absolute as well as relative terms. And not something you see very often on other companies’ balance sheets!
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Let’s go back up the list of assets, as we skipped a few line items. Accounts receivable of $28.2B. Invoices sent to clients that have not been paid yet. What’s the first financial metric that jumps to mind when talking about receivables?
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Days sales outstanding, or DSO. On average, how many days does it take for customers to pay the invoices sent by the company? We calculate DSO by taking the accounts receivable balance from the balance sheet, dividing it by the latest 12 months of revenue (found in the income statement), and multiplying it by 360 to annualize that number. $28.2B divided by $394B, times 360, is 26 days. Not a very high number, I have seen DSO at other companies at far higher levels.
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A nice piece of trivia, that will become more meaningful if we combine it with insights into other elements of working capital on the balance sheet. So what types of customers make up the accounts receivable balance? Note 3 gives us the answer:
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cellular network carriers, wholesalers, retailers, resellers, etcetera, etcetera. Cellular network carriers accounted for 44% of total trade receivables, that’s almost half the total amount!
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One thing to do to put the $28.2B of accounts receivable in perspective, is to compare it to the accounts payable balance. Accounts receivable: invoices sent to customers that are not paid yet. Accounts payable: invoices received from suppliers that are not paid yet. $28.2B versus $64.1B.
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So the “free loans” that suppliers are giving to Apple (accounts payable) are more than double the amount of the “free loans” that Apple gives to customers (accounts receivable). Good to know!
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How about inventories? Only $4.9B? Well, $4.9B is a big number, but for a company the size of Apple with $394B in revenue per year, that’s very small, isn’t it?
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The answer to that question lies in the next line item: vendor non-trade receivables. An item that I have not seen on other balance sheets before. Note 3 gives us the definition: the Company has non-trade receivables from certain of its manufacturing vendors resulting from the sale of components to vendors who manufacture subassemblies or assemble final products for the Company. In other words, Apple buys components for its products. It then sells these components
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to an outside manufacturer, who will assemble the products for Apple. While the assembly is taking place, prior to the finished product coming back to Apple, the outside manufacturer owes money for the components to Apple. Hence a current asset called vendor non-trade receivables on Apple’s balance sheet. Simply put, vendor non-trade receivables are “inventory-in-disguise”.
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Two vendors represent more than 10% of the amount, more specifically one vendor represents 54% of it. As you can read in the business and financial press, that company is Foxconn. Foxconn has been a great contributor to Apple’s success, but having so much of your outsourced manufacturing in the hands of one company also poses a risk to Apple.
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That is something that is good to know about the company!
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Let’s put together the pieces of the puzzle that we have just found. Apple’s working capital, the total amount of capital invested into the company’s operating cycle (its day-to-day operations) has five elements: accounts receivable of $28.2B, plus inventory of $4.9B,
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plus vendor non-trade receivables (which are also related to inventory) of $32.7B,
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minus accounts payable of $64.1B, and minus deferred revenue of $7.9B. That leads to a total working capital of minus $6.2B, which for Apple is a great thing. Its suppliers (through accounts payable) and some of its customers (through prepayments for services in deferred revenue) on the liabilities side of the balance sheet, are financing its customer balances in accounts receivable and its inventory on the assets side of the balance sheet. Wow. What a way to run your
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day-to-day operations, with zero working capital needed, or actually negative working capital!
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This also provides us an answer to a question we asked ourselves earlier: how come Apple has a current ratio of only 0.9? That is indeed mostly driven by working capital management.
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After the euphoria of coming up with that major insight, let’s see what else we find in the assets section of the balance sheet. Other current assets of $21.2B, with a related $54.4B in other non-current assets. If we sum those two numbers, we get to $75.6B in other assets, 21% of the balance sheet total.
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Sadly, these other assets are not itemized very well. By reading through various notes of the financial statements, we can come up with large balances in deferred tax assets, operating lease assets, and derivative assets, but we get nowhere near explaining the full amount. I find this very, very frustrating, and I think Apple could do a far better job in terms of transparency by NOT lumping together so many unnamed line items into a category called “Other”!
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Nothing we can do about it right now, so let’s move on to the next asset: property, plant and equipment, also known as fixed assets. Note 4 gives us the split of the gross value into 3 categories (land and buildings, machinery, equipment and internal use software, and leasehold improvements), and it reconciles gross value to net value through accumulated depreciation (how much has been depreciated so far). We can play around with this a bit,
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and find that 63% of the gross value has already been depreciated or amortized. We can also find in item 2 of the annual report, that “… the Company owned or leased facilities and land for corporate functions, R&D, data centers, retail and other purposes…”, in other words various functions other than manufacturing. Not much more than pieces of trivia, I’m afraid.
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Back to the bigger picture of the balance sheet. Assets equal liabilities plus equity. What can the liabilities section of the balance sheet tell us?
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We have already covered accounts payable in our discussion of working capital, so let’s move straight on to other current liabilities, and the other non-current liabilities further down. Here we go again! “Other”. Stuff not itemized specifically. Quite a lot of stuff actually: $110B, 31% of the balance sheet total. Just like with other assets, you can find some detail on other liabilities if you browse and browse and browse through the notes to the financial
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statements. However, most of the amount remains unexplained, leading to few if any insights, but lots of frustration for anyone trying to properly analyze this balance sheet.
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Deferred revenue is a balance sheet account (on the liability side, what a company owes) representing the obligation to deliver goods or perform services in the future for which billing has already occurred and/or cash has been received. Note 2 provides the % of total deferred revenue expected to be realized over the next few years. Nearly two-thirds to be realized as revenue within the next year. A nice piece of trivia, but not more than that.
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It gets a lot more exciting when we turn to commercial paper: unsecured short-term promissory notes issued to creditors. Might as well look at that in conjunction with current term debt (to be repaid within a year), and non-current term debt (to be repaid more than a year out from the balance sheet date). Now we’re getting to something very substantial. The sum of commercial paper, current debt and non-current debt is $120.1B (34% of total liabilities and equity).
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We did a similar calculation earlier on, looking at assets on the balance sheet. The sum of cash and cash equivalents, current marketable securities and non-current marketable securities is $169.1B (48% of total assets). Let’s deduct the debt from the financial assets. “Net cash and marketable securities” is $169.1B - $120.1B = $49B. That is a major insight! Those six very large items on the balance sheet net out to $49B. Financial assets and financial liabilities
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are such a big part of Apple’s balance sheet! They actually “blow up” both the asset side as well as the liabilities side of the balance sheet. If we turn to the income statement, we find that the income from the financial assets (through interest received and dividend income), is fully offset by the interest expense on the debt, so these large balances on both sides of the balance sheet are not really affecting net income in 2022. At the bottom right of the balance sheet
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is the pivotal section called shareholders’ equity. $50.7B. Now that we have reviewed the liabilities section of the balance sheet, we can finetune our debt-to-equity calculation, making it more “pure”, by narrowing the definition of debt to only interest-bearing debt (instead of total liabilities which we used earlier). $120.1B divided by $50.7B is a 2.4-to-1 ratio. What is on going on here? Apple is a highly successful company,
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that is raking in billions and billions of dollars in profit per year. How come their balance sheet is so highly leveraged? Or more specifically: how come the equity on the balance sheet is so low?
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Let’s look at which line item within equity appears to be unusual. This one right here: retained earnings (if the number is positive) or accumulated deficit (if the number is negative).
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How can a company that has been so immensely profitable for so many years have an accumulated deficit? Negative retained earnings? The answer to that question is found in a rarely used financial statement, called “consolidated statement of shareholders’ equity”.
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In there, we find the same ending balance of $3B negative in retained earnings, which is the ending balance of fiscal year 2022. We can follow how that number developed from the starting balance of $5.6B of retained earnings at the start of fiscal year 2022. Net income was huge for Apple in fiscal year 2022: $99.8B. This gets added to retained earnings on the balance sheet when closing the books at the end of the year. During the same year,
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fiscal year 2022, Apple declared dividends of $14.8B (shown between brackets, as a reduction), and repurchased stock for in total $90.2B. No wonder the retained earnings on the balance sheet are dropping year-over-year, when stock repurchases and dividends combined exceed net income! We are on to something here. Let’s take the balance sheets of previous years, and find out how total equity and more specifically the retained earnings balance developed.
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Turns out that retained earnings have dropped every single year in the past five years, while the company at the same time was very profitable. A financial statement paradox. Major insight coming up! Apple’s Shareholders’ equity on the balance sheet has eroded from $134B (of which $98B in retained earnings) at year-end FY17, to $50.7B at year-end FY22 (of which ($3B) in retained earnings),
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as the company year after year after year has stock purchases plus dividends (which deplete retained earnings) exceed net income (which makes retained earnings grow). At some point, Apple will have to balance those streams, or there will be no equity left on the balance sheet in a few years!
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Balance sheet numbers lead to insights on how a company works. Line item details, category totals, financial ratios, all of these give you the building blocks to your balance sheet insights. Sometimes you come up with a major insight, at other times something that is good to know, and often merely a piece of balance sheet trivia, or you come across a category where you don’t even have enough data to come up with any insight. It’s all worth it,
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when performing a solid balance sheet analysis! Want to learn more about business, finance, accounting and investing? Then subscribe to the Finance Storyteller YouTube channel, and start watching the next video in the recommendations on the screen. Thank you.
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