How to read a balance sheet: Alphabet Inc case study


How to read and analyze a balance sheet? This balance sheet tutorial is a companion
video to “How to read an annual report”, “How to read an income statement” and
“How to read a cash flow statement”, and covers the 2017 balance sheet of Alphabet Inc (the parent company of amongst others Google). The balance sheet is a fascinating financial
statement, you can learn a lot from it about the state of health of a company. Learning to read a balance sheet takes practice,
practice and practice, and some understanding of the key terminology. You have come to the right place for that! The balance sheet is an overview of what a
company owns and what a company owes at a specific point in time, in this case study
December 31st, 2017. When I analyze a balance sheet, there are
several things I always check, for each company I look at: the balance sheet total, which
should be the same left and right (what a company owns equals what a company owes);
the current ratio, a good indicator of a company’s liquidity; and equity as a percentage of the
balance sheet total, which gives an indication of how the company is financed, and what its
level of robustness is. Then I look specifically at several items
on the assets side, and several items on the liabilities and equity side. What those specific items are, I only decide
after taking a first look at the balance sheet of the company under review. It depends on the context. As always on the Finance Storyteller channel,
this video is for educational purposes only, none of the comments in this video should
be interpreted as investment advice. As the video is for educational purposes,
please do try this at home & comment on your findings below! In order to analyze the balance sheet, you
need to download the annual report. In the case of Alphabet Inc, go to abc.xyz/investor,
and download the 10-K PDF version. Scroll down the table of contents of the 10-K
annual report, up to item 8: financial statements and supplementary data. Click on the link. You now arrive at the index to the financial
statements, and the related notes. Click on “consolidated balance sheets”. Here’s the assets side of Alphabet Inc’s
balance sheet for year end 2016 on the left, and year end 2017 on the right. The balance sheet total is large: $197.3 billion
in 2017. It is also significantly bigger than last
year’s balance sheet total. Both in the income statement that we reviewed
previously, as well as the balance sheet, Alphabet Inc is growing considerably. To select specific items for further review,
I look at the absolute size of the line items, the movement (increase or decrease) versus
prior year, and the risk level associated with the item. On the assets side, more than half of the
total assets sit in cash, cash equivalents, and marketable securities: $101.9 billion,
up more than $15 billion versus the year before, worth taking a look at in more detail! Property and equipment is $42.4 billion, up
over $8 billion versus prior year. Lastly, goodwill is $16.7 billion, up only
slightly versus prior year, but significant in absolute terms. Cash, cash equivalents and marketable securities. $101.9 billion in total. Not as big as on Apple’s balance sheet,
but still one of the largest balances in the corporate world. Note 3 to the Alphabet Inc financial statements
provides details of where that balance is invested: $36.9 billion in U.S. government
notes, $24.2 billion in corporate debt securities, $11 billion in mortgage-backed securities. The cash, cash equivalents and marketable
securities portfolio generated an interest income of $1.3 billion in 2017, recorded in
other income in the income statement. If Alphabet Inc wants to make any significant
incremental investments in their business (either for organic growth, or growth through
acquisition), they have the money ready! These are very liquid investments, easily
convertible to cash. Property and equipment. The balance of property and equipment was
$42.4 billion at year end 2017, up $8.1 billion versus year end 2016. In the cash flow statement analysis, we saw
that the CapEx cash outflow in cash from investing activities was $13.2 billion in 2017. The major balance sheet components in the
property and equipment balance at the end of 2017 were land and buildings $23.2 billion,
information technology assets $21.4 billion, and construction in progress $10.5 billion. While the gross value of property and equipment has gone up significantly, the accumulated depreciation has also increased, as the value of the assets in use is allocated to the years of usage. Goodwill. One of my favorite items to review on a balance
sheet, as it tells a lot about the way the company has grown over the years. A high goodwill balance is an indication of
significant acquisition activity in a company’s history. Goodwill is the excess of the purchase price
paid for acquired firms, over the fair value of its separately identifiable net assets. Goodwill can be a major risk item on a company’s
balance sheet, if the performance of the acquired company does not live up to expectations;
an impairment (one-time write off) might then be needed of part of the goodwil. In the case of Alphabet Inc, the goodwill
balance at year end 2017 is $16.7 billion, which is up only relatively slightly compared to the last year and the year before (yes, a few hundred million dollars qualifies as “slightly” in the context of Alphabet Inc). To find a more significant increase in the
goodwill balance, you have to go back to the 2014 annual report. In 2014, goodwill went up more than $4 billion
from $11.5 billion at the start of the year to $15.6 billion at the end of the year: $2.3
billion due to the Nest acquisition, $452 million for the Dropcam acquisition, $388 million for the Skybox acquisition, and $1 billion for other acquisitions that year. Going through the history of Alphabet Inc’s
acquisitions feels like a technological journey through time, and gives an indication of the
breadth of the portfolio. Time to check on our progress on the balance
sheet analysis. So far, we have been able to check the balance sheet total on the assets side, and reviewed in more detail selected asset items such as
cash and marketable securities, property and equipment, and goodwill. Now it’s time to turn to the other side
of the balance sheet, to review liabilities and equity. What a company owns (assets) has to equal
what a company owes (liabilities and equity), so our first check here is that the total
at the bottom of the page is $197.3 billion. Within that total, by far the biggest amount
is in equity (shareholder capital): $152.5 billion or 77% of the total. That’s unusually high in both absolute and
relative terms, but makes the company very robust. Within equity, nearly three quarters is in
retained earnings. As Alphabet Inc is very profitable, has historically
not paid a dividend to its shareholders, and does not expect to pay any cash dividends
in the foreseeable future, this retained earnings balance keeps on growing and growing. In comparison to the equity balance, all other
line items on this page seem tiny, even though in absolute terms they might still be sizeable. Two items jump out, as they are larger than
$10 billion at year end 2017, and because the balance has gone up significantly year-over-year:
income taxes payable, and accrued expenses and other liabilities. Let’s review what is going on there. Income taxes payable. The details on this balance sheet liability
account are not directly given to us in the Alphabet Inc annual report, but there are
other ways to get an idea of what is going on. What you see here is the overview of the provision
for income taxes in the income statement. $14.5 billion in total in 2017, much higher
than in previous years. The vast majority of the amount, and the majority of the increase, is from federal and state taxes. The narrative at the bottom of the page explains
the impact of the US Tax Act of December 2017. In the case of Alphabet Inc, the main item
having an impact in 2017 was the one-time transition tax, which was recorded as a debit
to income tax expense in the income statement, but as it was not paid yet in cash, the credit
went to the liability account called income taxes payable on the balance sheet. The December 31st 2016 and December 31st 2017
balances, as well as the main line items, for accrued expenses and other liabilities
are shown in a note to the financial statements. The European Commission fine of $2.9 billion
stands out here. This is the fine that the European Commission
has announced, which Alphabet is appealing and has not paid yet. Alphabet Inc has recorded the fine as an expense
(debit) in the income statement, and the offset (credit) to that journal entry was accrued
expenses and other liabilities. In other words, the expenses are recorded,
but the settlement or payment has not occurred. Time for a progress check on our balance sheet
analysis. So far, we have been able to check the balance
sheet total on the assets side, looked at equity as a percentage of the balance sheet
total, and reviewed in more detail selected asset and liability items. Now it’s time to connect both sides of the
balance sheet (assets – what a company owns, and liabilities and equity – what a company
owes) to see the bigger picture. The current ratio is one of the ways to connect
both sides of the balance sheet. The current ratio looks at current assets
versus current liabilities. Current assets are things that are already
cash or are likely to become cash within 12 months. Current liabilities are things that need to
be paid in cash within 12 months. If the current ratio is high, then that means
that a company has a high liquidity. In the case of Alphabet Inc, the current ratio is very high at 514% ($124.3 billion in current assets over $24.2 billion in current liabilities). For every $1 in current liabilities, $5.14
in current assets. If Alphabet Inc owes you money, they are highly
likely to be able to pay you. We have succeeded in performing a high-level
balance sheet analysis of Alphabet Inc, by focusing on five areas: balance sheet totals,
current ratio, equity as percentage of the total, and selected items in assets and liabilities. I am very interested to hear your comments,
please post them below the video. Thank you for watching! If you enjoyed this explanation of how to
read a balance sheet and how to perform a balance sheet analysis, then please give it
a thumbs up! On this end screen, there are a few suggestions
of videos you can watch next. Please subscribe to the Finance Storyteller
YouTube channel! Thank you.

13 Replies to “How to read a balance sheet: Alphabet Inc case study”

  1. Thank you for your sharing of analysis of the 3 financial statements of Alphabet Inc. They are all professional presentations. 2 thumbs up!! Please allow me to be greedy a bit, may I request you to go further, based on those figures, to discuss the Discounted Cash Flow model as well the WACC. These two reports are important to forecast the value of the company in the near future, and also make the analysis as a whole perfect.
    By the way, you did the current ratio on the balance sheet, do we need to do ratios of other items? Do we need to do ratios on the other two financial statements as well? Thanks again for your kindness.

  2. When you looked at liabilities, you expected the exact same total as the assets. Why? Wouldn't you expect that since they're doing well, they'll have more assets than liabilities? Even if it was close, why would it be exactly the same?

  3. Is there any correlation between current ratio and CFOA? When the Current ratio is below 1 and CFOA is positive (and increased), can we say the company have liquidity problems?

  4. Another great explanation in clear terms. I also watched your most helpful video on "how to make videos" but already knew that you followed a highly-structured approach, which seems to be based on Minto's pyramid principle. Are you in fact using this to structure your thinking and content? An observation in this particular video, and it is not a criticism, is that your 'key line' or 'To Do List' at about 1:20 mentions 5 items but you deal with the second item last. Is there a specific reason that you listed the items in this order but dealt with them in precisely the same sequence expect for the second item? Another question that I have is also from a non-financial person perspective. When I attended a (very poorly presented) course on financial statements I recall being told that the Net Profit is "a balancing item in the Balance Sheet". The example used on that course showed this clearly as a line item ('net profit for the period' ? equal in value to the line in the IS) but almost every published BS I look at does not list this as a line item. Could you please help me understand why and how does this line item for "net profit for the period" become 'distributed' among the line items shown in a typical BS? The current example company I am analyzing does however have an item for "cash and cash equivalents" that precisely matches with that in the CF statement.

  5. hello.
    first i wanna say thanks about the video is very effective.
    second if i want to check how much company pay each year on the bond that the are sell,
    where i can find it?
    thanks

  6. Thank you! This was very clearly stated, and I will use this knowledge every day! You're awesome for doing this!

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