Balance Sheets

Shine sweet freedom
Shine your light on me
You are the magic
You're right where I want to be
--Michael McDonald

In the last two missives we examined income statements and cash flow statements. The last of the financial statement trilogy is the balance sheet. We touched on the balance sheet a few posts ago when discussing net worth. A balance sheet reports what is owned (assets) and what is owed (liabilities). The difference between the two is called net worth, or in the case of investors, 'shareholder equity.'

The key information I like to glean from a balance sheet is how much cash a company has versus how much debt it has. Cash is freedom and flexibility while debt, as we have noted, reduces freedom and limits future options. Cash, short term investments, and other cash 'equivalents' are usually the first thing reported under the Asset section of the balance sheet. Once again returning to our Intel (INTC) example, the company's most recent annual balance sheet reports $3.0 billion in cash and cash equivalents and another $2.8 billion in short term investments (all of these are liquid, cash-like assets). Intel's total cash, then, is $3.0 billion + $2.8 = $5.8 billion.

We can also see that the company's total cash has been declining over the past four years (it had been $18 billion in 2015). That's a negative. We'd rather see it going up over time.

Now let's look at long term debt, usually reported near the end of the Liabilities section. For its most recent fiscal year, Intel reports $25.1 billion in long term debt. Long term debt has also been increasing over the past four years. That's undesirable; we'd rather see it going the other way.

We can compare cash to debt in a couple of ways. We can find 'net cash' by subtracting long term debt from total cash. For Intel, net cash = $5.8 billion - $25.1 billion or -$19.3 billion. We could also calculate the ratio of cash to long term debt: $5.8 billion/$25.1 billion = 0.23.

The strongest balance sheets are those where there is more cash than long term debt (positive net cash; cash:debt > 1.0). That way, a company can quickly use cash to extinguish debt and gain more flexibility.

Once upon a time, many companies operated with strong cash positions. Unfortunately, in the debt-laden world that we live in, that kind of balance sheet strength is largely a thing of the past. Most corporate balance sheets have weakened considerably. Not too long ago, Intel had gobs of cash and zero debt--a bastion of balance sheet strength. Personally, I've had to become more comfortable situations like Intel's and resolve to invest in companies with balance sheets that are 'less bad' than others.

That completes our synopsis of the financial statement trilogy. With a little practice you can navigate these statements like a pro for info that will make you a more knowledgeable investor.

position in INTC