What is Goodwill on a Balance Sheet?

What is Goodwill on a Balance Sheet?

By Preston G Pysh

There are a variety of different lines on a balance sheet, and if you really want to understand the sheet in its entirety, it is vital that you understand each line.

[caption id="attachment_1037" align="aligncenter" width="605"] What is Goodwill on a Balance Sheet?[/caption]

Understanding each line goes further than just knowing what it means. You should also learn how it can affect you. Let's start by taking a look at the Goodwill line on a balance sheet. This is one of the lines that is most often misunderstood. Some people have even misunderstood it to be the amount of money that businesses donate to charity. This is very far from the real meaning of Goodwill on a balance sheet.

The easiest definition of Goodwill on a balance sheet is basically what comes about when two companies merge together. Two separate businesses merge together, and this can create some confusion for some people. Let's say the first business is buying out the second business. When this happens, there is a lot more to it than simply merging together. The first business will start by determining the worth of the second business. Then, they deduct any liabilities owed by the second business, because these will also be transferred with the merge.

It is key to remember that when companies merge together, the balance sheets are also merged together. When buying out another business, the amount paid for the business is likely going to be more than the actual book value of the business. This is due to the stock value of the business. The difference between these two values will give you the Goodwill value. While the assets of the new balance sheet will be higher, so will the liabilities. These are all things that should be taken into consideration when a merge is in question.

The Goodwill value can sometimes be highly inflated, especially if the stocks for the business are highly inflated. This can prove to be quite deceiving for the buying company, but can ultimately cause the other company to make a larger profit on their business. The best way to avoid paying too much for a business is by analyzing the stock markets and market shares well in advance. It is also a good idea to recognize the trends in the stocks before making a concrete decision.

The Goodwill value is generally included in the assets of the business, along with tangible assets. It is a different type of asset. It is definitely not one of the tangible assets that can be sold during economic downturns when you need to raise money for your business. Considering the fact that stock prices can change on a day to day basis, some businesses end up losing money when they buy out another business when the stock shares are priced higher.

If you have ever been baffled about the Goodwill line on the balance sheet, this should help to put any questions that you may have had to rest. It is definitely something that many people misunderstand. A misunderstanding of this line can have detrimental results for the profitability of a business.

If you would like to learn more about goodwill on a balance sheet, be sure to click on this link because it provides more information and a wonderful video on how it applies to Warren Buffett style investing.

Also, if you would like to learn how Warren Buffett invests, this link takes you to a comprehensive site that teaches his investing techniques.

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What is a Balance Sheet and How Can I Use It for Investing?

What is a Balance Sheet and How Can I Use It for Investing?

By Preston G Pysh

A balance sheet is a financial statement that provides information about the company's assets and liabilities and the shareholder's equity. There is a specific formula that all sheets follow. Basically, the assets of a company equal the liabilities plus the equity of the shareholders. The point of a balance sheet is to ensure that both of the sides balance out to be equal. The company will have to pay for their assets by using loans or shareholders' equity.

[caption id="attachment_1033" align="aligncenter" width="500"] What is a Balance Sheet?[/caption]

Let's take a closer look at the three main components that make up the sheet.

Company Assets

A company's assets are basically the items that the company owns that are valuable, and in most cases they were paid for by the company or donated to them. There are many different asset types. These include cash assets, receivables, property, and many others.

Company Liabilities

A company's liabilities include the items that the company must pay out to other people, including other businesses, individuals, or government agencies. There are many different liability types. These include current liabilities, short term liabilities, long term liabilities, and many others.

Stockholders' Equity

A company's stockholder equity is basically the amount of money that investors have put into the company. Some of this will also include profits that the company has kept to use for new projects that are business related.

Sheets are used to reconcile accounts. Assets should always be equal to the amount of liabilities and equity. Therefore, the equation is A = L + E, or Assets = Liabilities + Equity. It is fairly simple to understand.

A balance sheet can also be used to see where a business stands financially. Investors should always be aware of the businesses that they entrust their investments with. A good way to ensure that you are making wise investment choices is to take a look at the sheet to ensure that they even out. Shareholders will definitely want to know where they stand on these financial documents.

Another group of people that commonly view these finances are potential creditors. Creditors that help out businesses will want to know that a business is able to check and balance their assets and liabilities. This helps to show them that they are making wise loans to the business.

Analyzing a balance sheet may not be as easy as it sounds. The best way to analyze these sheets is through the use of ratio analysis. There are three different ratios to consider. These include class liquidity ratios, solvency ratios, and profitability ratios. Each of these ratios shows a particular business aspect.

If you really want to improve your business and investment moves, then you will want to make sure that you focus on learning the in's and out's of the balance sheet and how they can affect you. Don't glance blindly at a balance sheet without understanding how to properly analyze it. This can be very detrimental, especially for people who are new to investing.

If you would like to learn more about what a balance sheet is, be sure to click on this link because it provides a great video lesson on the subject.

Also, if you would like to learn investing like Warren Buffett, this link takes you to an in-depth site that teaches his investing approach through 10 hours of YouTube videos.

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What is a Cash Flow Statement?

What is a Cash Flow Statement and How Can Investors Use It to Their Own Advantage?

By Preston G Pysh

The cash flow statement is a statement produced by the public companies on an annual basis in order to identify the inflows and outflows of cash. As opposed to the income statement that identifies the profit for the year, the cash flow statement provides a true picture of the cash in hand of the business. Thus, this statement is useful for understanding the liquidity position of the company. The cash balance presented in the balance sheet is tied with the profit shown in the income statement and therefore the cash statement provides a link between the statement of financial position and statement of comprehensive income.

[caption id="attachment_1030" align="aligncenter" width="500"] What is a Cash Flow Statement?[/caption]

The cash flow statement identifies various sources of inflow and outflow of cash which are categorized into three major aspects namely operating, financing and investing flows of cash. The operating activities measure the cash that arises as a result of business operations and this starts with the profit after tax as reported in the income statement. Non cash expenses such as depreciation are added back to the PAT whereas accruals of interest and tax expense are adjusted so that the cash outflow is determined.

Changes in the working capital are identified and these are also adjusted accordingly in order to arrive at cash generated from operating activities. The next component of the statement is the investing cash that largely pertain to the capital transactions of the business. Any purchase and sales of property, plant and equipment is recorded in this section in order to identify the net cash from financing activities. Lastly, the financing section highlights the business transactions that are meant to raise finance such as debt issue, equity issue or loan repayment. The financing section highlights the changes in capital structure that came about in a given year. The net result of the cash from operating, investing and financing activities is the cash flow generated during a given year. This is then added with the balance at bank at the year start so that the balance at the year end is computed. This is then verified with the balance shown in the current assets within the balance sheet.

The cash flow statement is of immense importance to the investors as they can identify transactions that are not depicted in the balance sheet and income statement. The company's cash position determines the liquidity of the firm and the change in cash from year start to the year-end would help the investors in identifying the change in liquidity position. An assessment of the liquidity would enable the investor to identify the ability of the business to pay off its debts with ease.

The cash flow statement can also be used by the investors to identify the free flow of cash within a business. This information is not presented by the income statement that is based on the concept of accruals and prudence. The free flow of cash within a business would help in identifying the true cash that's generated as a result of the operations after the deduction of any capital expenditure that is required to maintain the operations of the company. Low or negative cash flows would indicate the lack of operating efficiency of the business and therefore investors must analyze the FCF of a given firm over a period of time.

The cash flow statement is also an indicative of the current capital expenditure policy of the firm. The investing section would highlight the expenditure on equipment. A negative or a positive investing cash flow does not indicate the true position of the company. A negative cash flow might arise as a result of high capital expenditure in a given year whereas a positive investing cash flow could come about as a result of sale of equipment. These are one off items and must not be used as a means to assess the liquidity position of a company. An investor can therefore identify the underlying reasons for negative or positive cash flow and therefore ascertain the future stream of cash flows. For example, a large outflow in the present year might result in low or negative cash balance but it is likely to result in more efficient operations which would enhance profitability and thus earning per shares. The investor can therefore use this information to predict the future profitability and operating capacity of the organization.

Furthermore, the finance section depicts the financing activities of the business and allows the investor to ascertain the changes made within the capital structure in a given year. For example, an investor can analyze the increase in debt or equity in a given year and therefore ascertain the changes in financial risk that a firm faces. An investor would also be able to determine the true reason for the cash in hand. For example a low cash balance might indicate low liquidity at a glance. But in reality it might be as a result of debt repayment which is a one off item and therefore the investor would easily be able to conclude that the business at present does not face a shortage of cash due to inefficient operations but simply because of repayment of debt.

An investor is thus able to analyze the various inflows and outflows of cash from the cash flow statement and also ascertain the sources of cash. Investors are able to identify the free cash flows generated from operations and therefore are able to analyze the ability of the business to pay back its debt while also meet its interest payments. The growth prospects and the ability to pay out dividends can also be predicted from FCF. The investor is able to analyze the investment policy of the company for example a firm is likely to pursue an aggressive investment strategy if there are capital outflows over a period of time. Thus, the cash flow statement is of immense importance to the investors who can use it to ascertain the various sources of cash inflow and outflow.

If you would like to learn more about what a Cash Flow Statement is, I would recommend watching this 15 minute video from YouTube. The video provides some really good tips on how an investor should view the statement.

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What is a Bond's Yield to Call?

What is a Bond's Yield to Call?

By Preston G Pysh

Any investor that is looking forward to investing in bonds must have an understanding of the term yield to call. Some bonds are callable meaning that they can be redeemed before the maturity date by the issuer at a call price that is slightly higher than the par value of the bond. Normally, bonds are called five to ten years after the date of issue and these types of bonds are regarded as call protected securities. This means they can be redeemed before the maturity date. The date at which the bonds are called for redemption is essentially known as the call date.

[caption id="attachment_1027" align="aligncenter" width="500"] What is a Bond's Yield to Call?[/caption]

Investors are interested in the returns that would be generated by the bond over the period of investment. The cash flows associated with a bond are usually the initial outflow at the market value of the bond and the later inflows in terms of interest payments and redemption value. These three primary factors determine the yield of a bond. The basic definition is the rate of return that would be earned by an investor if the investor buys a callable bond. The yield to call is the discount factor that results in the future cash inflows to generate a present value that is equal to the market value of the bond.

The yield that occurs once a bond is called is applicable only if the bond is redeemed before the date of maturity. The yield to call calculation has an inherent assumption that the investor can reinvest the interest payments at a specified rate. However, this assumption does not hold true in the real world and therefore critics argue that this calculation does not provide the true rate of return for the investors. This calculation also assumes that the bond holder will hold the bond until the call date and the issuer will call the bond at the earliest date possible. However, this may or may not be true.

The yield of a bond is likely to be lower than the yield to call calculated on the basis of redemption value, market value and coupon payments. This is because the issuer has the power to call the bond before the date of maturity and this acts as a barrier for price appreciation. The price of a called bond will not rise above the call price even when market interest rates fall below the coupon rate. This is due to the fact that the organization is likely to redeem the bonds as soon as the market conditions turn favorable. Therefore, although the yield to call calculation provides the rate of return that would be earned by an investor who invests in a callable bond, this calculation is subject to limitations due to inherent assumptions and nature of the security.

If you're interested in using a yield to call calculator, be sure to follow this link to a online calculator.

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What is a Bond Yield Curve?

 What is a Bond Yield Curve and How Do Investors Use Them?

By Preston G Pysh

The more advanced you become in stock and bond investing, the more familiar you'll become with a thing called a bond yield curve. This graph is probably one of the only tools you might find that can aide in predicting market trends. Since interest rates are ultimately controlled by the Federal Reserve (FED), tracking the way that the FED adjusts these rates can really help your investing approach.

[caption id="attachment_1025" align="aligncenter" width="500"] What is a Bond Yield Curve?[/caption]

The yield curve is broken down into two axis'. The x-axis is the term of the federal bill, note, and bond. While the y-axis is the corresponding yield for each of those securities. In order to show how all the investments are inter-related, a line is drawn between them on the graph. If you'd like to see what a yield curve looks like, simply google the term and you'll see a multitude of examples.

You see, the FED is completely reactionary. If the market goes down and jobless rates increase, they increase the supply of money so interest rates decrease. Inversely, if the market is booming and employment is very high, the FED gradually raises interest rates in order to prevent a future market bubble. This cycle, which some argue is the result of the FED itself (and I kind of agree), is something that will continue to occur in the future as long as we have a central bank for the country.

So how can you take advantage of this behavior as a stock and bond investor? Well for starters, let's talk about bonds. We know that the market value of a bond is directly related to interest rates. If we look at a current bond yield curve in 2012, you'll see a positively sloped graph that depicts the yield on long term bonds much higher than short term notes and bills. This is important because it's the FEDs way of saying, "Hey we don't think these low interest rates are going to last for a long period of time. In fact, over a 30 year period we think the average yield will be X (insert the yield from the intersection of the 30 year bond and line on the chart)" Knowing that the market value of a bond decreases when interest rates increase, we can rest assure that buying bonds in 2012 is probably a very poor financial decision.

With respect to stocks, we know when the yield curve is positively slopped, short term interest rates are low and it probably means it's a great time to be purchasing common shares.

Although this article only provides a very quick and ruff way to examine yield curves, active investors should really try to learn more about this wonderful tool.

If you would like to watch a 15 minute YouTube video on how bond yield curves work, be sure to click on this link. This takes you to a wonderful site that shows you how to access bond yield curves and applies the information to previous market conditions.

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