How to Use Financial Reports to Calculate the Quick Ratio Presenting Financial Reports: Turning Numbers into Information How to Use the Fixed Asset Turnover Profitability Metric

# Looking at Fixed Assets in a Balance Sheet

Virtually every business needs fixed assets — long-lived economic resources such as land, buildings, and machines — to carry on its profit-making activities. In a balance sheet, these assets typically are reported in a category called property, plant, and equipment.

The cost and accumulated depreciation of a business’s fixed assets depends on the following:

• When the assets were bought (recently or many years ago?)

• The sort of long-term operating assets the business needs

• Whether the business leases or owns these assets

It’s very difficult to generalize about the cost of fixed assets relative to annual sales revenue. A ballpark estimate for this ratio might be that the annual sales revenue of a business is generally between two to four times the total cost of its fixed assets.

But take this estimation with a grain of salt. The ratio varies widely from industry to industry, and even within the same industry, the ratio can vary from company to company. Generally speaking, retailers have a higher ratio of sales to fixed assets than heavy equipment manufacturers and transportation companies (airlines, truckers, and so on).

In the figure below, you can see an educated guess for the fixed assets’ cost and the accumulated depreciation on the fixed assets for Company X. The partial balance sheet shown in the figure tells an interesting story: Company X has \$3,855,000 total assets, but where did it get that \$3,855,000?

Its two operating liabilities provided \$515,000 of the total assets (\$350,000 accounts payable + \$165,000 accrued expenses payable = \$515,000). So where did the remaining \$3,340,000 come from?

\$3,855,000 total assets – \$515,000 short-term operating liabilities
= \$3,340,000 needed from sources of business capital
Company X’s balance sheet that includes assets and short-term operating liabilities.

The two basic sources of business capital are interest-bearing debt and equity (more precisely, owners’ equity). Where to secure capital is really a business financial management question, not an accounting question per se. As a practical matter, many businesses borrow as much as they can and use owners’ equity for the rest of the capital they need.

The next figure presents the complete balance sheet for Company X, including its debt and owners’ equity accounts. The business has borrowed \$500,000 on short-term notes payable (due in one year or less) and \$1,000,000 on long-term notes payable.

The complete balance sheet for Company X.

Balance sheets may or may not report the annual interest rates on their notes (and bonds) payable. If not reported in the balance sheet proper, interest rates and other relevant details of debt contracts are disclosed in the footnotes. For example, debt covenants (conditions prescribed by the debt contract) may limit the amount of cash dividends the business can pay to its shareowners.

The shareowners in Company X invested \$750,000, for which they received 10,000 capital stock shares. Even relatively simple-looking business corporation ownership structures can be more complex than they appear. Typically, a footnote is necessary to fully explain the ownership structure of a business corporation.

As a general rule, private business corporations don’t have to disclose who owns how many of their capital stock shares in their financial statements. In contrast, public business corporations are subject to many disclosure rules regarding the stock ownership, stock options, and other stock-based compensation benefits of their officers and top-level managers.