Most of us are familiar with the classified balance sheet where assets and liabilities are categorised based on longevity – current or non-current. This is the conventional practice, but it is not perfect. For example, in calculating the traditional Return on Assets (ROA) as a measure of operational efficiency, the denominator includes peripheral assets which reduce the calculated value. Companies with investment properties, high cash balances are penalised. To deal with imperfections of the conventional balance sheet, we will be reformulating the balance sheet based on Stephen H. Penman’s teaching.
Instead of classifying assets and liabilities according to their longevity, the balance sheet is now reformulated based on their utility – operational or financial. Assets and liabilities are first rearranged into either operating or financial assets/liabilities. Some examples are included in the table below.
Examples | |
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Financial assets | Investment securities, excess cash and investment properties |
Financial liabilities | Short term and long ... |