RULE 75: Know Why You Should Be Able To Read A Balance Sheet-And How

Actuarist, Chief Ishola Ogunshola with Oil Baron, Aare (Dr.) Bolu Akin-Olugbade

If you are going
to run a company or invest in companies, you need to be able to read a balance
sheet. This is different to knowing what profit or loss a company has made
(i.e. reading a profit and loss account). Why? Because a profit and loss
account only shows you half the picture; for instance, Company X might have a
turnover of N1 million and expenses of N500,000, thus it has made a profit of
500,000 and must be doing really well, n’est-ce
pas

No, actually Because what you can’t see from this simple profit and
loss account is that it owes the bank N2 million, the N1 million in turnover is
very dodgy and there is a N4 million tax bill hanging over its head from
previous years’ accounts, a franchise expiring, tax loop hole about to close
and a powerful competitor about to start up.
Invest in
Company X? I don’t think so. It’s bankrupt and fraudulently trading and not
worth a pig’s ear. Stay away; So, you need to see a balance sheet without fail.
And because of what it is not telling you. A balance sheet has to
balance. That’s why it’s called a balance sheet. The basic formula you need to
know is Assets minus Liabilities = Equity or A – B = C. Into even simpler
terms: what you own less what you owe equals what you are worth. This applies
to you, companies you work for/own and companies you intend investing in. 
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 “So if you just hear about a company that has made a
profit of N1 million and are offered the chance to invest, don’t be impressed
by that single figure. Ask to see the balance sheet. Read it thoroughly
”.

A BALANCE SHEET
MUST BE BALANCED
Let’s have a
closer look.
A:
What you own – your assets. Made up
of current assets including cash and anything that can be realized (i.e. turned
into cash) within say a three-month period (this might include cast-iron
debtors, money in transit etc.); stock (stuff ready to be sold and raw
materials that have value and can be made into products); any property you or
the company may own; equipment and goodwill.
B: What
you owe – your liabilities
. This includes your creditors, long-term loans
and bank loans. Basically what you would have to find in cash if everyone
called in what you owed them.
 C: What you are worth – your equity. This
is A minus B. It tells us what you or your company is really worth. There is a
formula that says that you take your current assets and divide it by your
liabilities and if the answer is bigger than 1.5 you’re doing OK.
Obviously you
need to adjust this for different industries and businesses but it serves as a
basic indicator. I also take the equity and divide it by the assets as a
percentage. And if the answer is higher than 50, I feel confident. For instance
equity 35 million divided by assets (capital employed) of 70 million as a
percentage = 35,000,000 divided by 70,000,000% = 50 which is fine. But assets
of 120 million and equity of 35 million is not so hot – around 29.
So if you just hear about a company that has made a
profit of N1 million and are offered the chance to invest, don’t be impressed
by that single figure. Ask to see the balance sheet. Read it thoroughly. In
fact, don’t just read the balance sheet; important as it is, there are other
things you need to know, such as a company’s financial statements in total. The
more information you can get (and should get), the more solid your decision
will be.
From The Book; The Rules of Wealth by
Richard Templar
(Read Rule
76
of Rule of Wealth tomorrow on Asabeafrika)

Read-to-Wealth Series








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