A sense of debt

Jan 20, 2023

In the previous two posts, we explored how assets are grouped in a company's balance sheet.
Part 1: Balance sheet: taking the first steps
Part 2: Assets I prioritize

Now let's deal with Liabilities and Stockholders' equity. Let me remind you that these are the sources of funds that give a company assets. And indeed, with what funds can a company have assets? Either with its own funds (stockholders' equity), or with funds borrowed (liabilities). For simplicity, we will call them Debts and Equity.

Debts can vary in maturity, so we've divided them into two categories in the balance sheet: Current liabilities and Non-current liabilities.

Current liabilities include:
- Current debts are debts that need to be paid back within a year after they are incurred. Do you remember our master took a loan from the bank to make a large batch of boots? That loan will be recorded in this item (assuming the loan is up to one year in repayment).
- Accounts payable (debts to suppliers of goods and services). You can borrow money not only from the bank, but also from your suppliers, for example. In other words he is giving you raw materials now, but is ready to accept payment later. Such debts are reflected in this item.
- Accrued liabilities (Provisions for future expenses on unpaid bills in the form of wages, rent, taxes). The word "debt" is in many ways synonymous with the word "liability." A company may have many such liabilities: payment of wages, rent and taxes. In essence, these are also debts to be paid during the year. For convenience, cash reserves are set aside for them. They are spent at the moment when the payment is due. Such reserves are recorded in this item.
- Other current liabilities. Debts or liabilities with a maturity of up to one year that are not included in the categories above are shown here.

Non-current liabilities include:
- Long term debt - these are debts that need to be paid back more than one year after they are incurred. If our master had borrowed from the bank for two years, such a loan would fall into this category.
- Deferred taxes liabilities (Provision for taxes to be paid in a future period). Tax rates are subject to change, and new taxes may come into effect in a year or more. But even now, the company can set aside money for future taxes.
- Other long term liabilities. Here are debts or liabilities with a maturity of more than one year that are not included in the categories above.

In short, debts are loans taken by the company, provisions for tax liabilities, and debts to suppliers.

The amount of debt is a very important indicator in the fundamental analysis of a company. On the one hand, the mere presence of debt is not scary, because it demonstrates that banks trust the company and give it loans for development. On the other hand, a substantial amount of debt can cause serious problems and losses in the period of weak sales of goods or services. Banks are unlikely to suspend interest charges on loans if a company is doing poorly. This means the company will incur expenses in the form of interest on loans that are not offset by revenue. Also a reminder that if a company goes bankrupt, the owners of the stock get the assets of that company only after all debts have been settled. If the debts are so large that they exceed the value of all the property, the shareholders get nothing. For these reasons, I select companies with small debt loads.

What liabilities do I focus on?
- Current debt;
- Accounts payable;
- Long term debt.

For me, these are the items that most clearly reflect the company's debt situation.

In the next post, we will conclude our study of the balance sheet and look at the basic source of assets, which is Equity. See you soon!