Judge the quality of a company's balance sheet
The idea
Evaluating balance sheet quality means adjusting reported figures towards economic reality. Add off-balance-sheet obligations, such as guarantees or recourse factoring, to liabilities; treat a pension deficit as debt; check goodwill against the performance of the acquired business and consider writing it down or excluding it when comparing companies; and examine whether Level 3 fair values or aggressive capitalisation inflate assets. Then recompute leverage and coverage on the adjusted basis. A company whose debt to equity looks moderate may look stretched once obligations are added and inflated assets removed. The trap is adding a liability without the matching adjustment to equity or assets, so the adjusted figures no longer balance.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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- Show how a conceptual framework is used to judge how reliable and useful a company's financial reporting is
- Explain problems that can undermine the quality of financial reports
- Explain the process for judging how good a company's financial reports are
- Judge how good a company's financial reports are
- Explain the signs that indicate earnings quality
- Explain what is meant by sustainable (persistent) earnings
- Explain why earnings revert to the mean and how accruals change how quickly they do so
- Judge the quality of a company's earnings
- Judge the quality of a company's cash flows
- Explain the signs that indicate balance sheet quality
- Explain the signs that indicate cash flow quality
- Set out where information about risk can be found