A balance sheet should capture the assets, liabilities, and equity of a company. The three items give potential investors an overview of the assets owned by the company, the obligations to other people or businesses and the equity owed to the shareholders or the money they invested in the company. A company is required to pay for any obligations it owes and therefore such liabilities should not be the force it to enter into financial difficulties by being unable to pay the debts as they fall due (Loughran, 2011).
The debt structure of an investment which is the composition of its owners’ contribution and debt is an essential element for any potential investors who favor companies with strong fundamentals. A company’s balance sheet can be insightful for investment purposes. Companies with more equity than debt are less risky than similar firms that are highly geared. Such investments are risky because an increase in the debt level in future will make it difficult for it to repay and service its debt. Potential investors are looking for companies with low debt to equity ratios. The obligation of a company is usually equated with its liabilities (Loughran, 2011).
Delegate your assignment to our experts and they will do the rest.
Some businesses have operational liabilities which are not reported on the balance sheet. They do not indicate comprehensive overall debt information for the company. Such figures are included in the notes to the balance sheet also called footnotes. Some of the example of data that is not recorded in the balance sheet by most companies includes operating lease and pension. The off-balance sheet obligations are usually difficult to identify, and the potential investor can be misled by the value recorded on the balance sheet which is lower than the actual responsibilities of the company. From the information provided by Target Company, the total liability recorded on the balance sheet by the year-end was $29,253 against an asset base of $44,560 (Loughran, 2011).
Not all leases are recorded in the notes to financial statements. Capital leases are recorded on the balance sheet as the company has the option of owning the property at the end of the lease period. If specific criteria are met for a capital lease, then it is considered a purchase of the asset under the lease agreement. Such contracts affect the balance sheet because the periodic payments are broken down to depreciation and interest expenses. Assets qualify to be capital leases if seventy-five or more of their useful life is the lease time. Similarly, it must comprise an option to buy, and it must change ownership at the end of the lease. Lastly, the PV of the periodic payments must exceed 90% of the market value of the asset. Operating leases, on the other hand, are agreements that enable the lessee to use an asset but ownership rights are not conveyed to them. The lease payments are categorized as rental expenses (Loughran, 2011).
A look at the notes to the financial statements on leases, rent costs for the three years from 2005 to 2007 was $154, $158 and $165. The amounts include percentage rent expenses of $5 million for the three years. The long-term leases can be renewed for up to 50 years. Some of the leased property has purchase options, and therefore the company can buy them (Loughran, 2011).
From the projected future leases, it is evident that the company will be exposed to more operating and capital leases which will also increase the level of dept from the current 74% as computed by Tom to a higher percentage. Such a move will make the company more risky as a decline in its sales volumes will make it hard for Target to service its debt. If the share of equity does not change in the future, it implies that by 2010 Target Company will have more obligations compared to its capital. It will, therefore, be exposed to liquidity risks as debt holders would need their cash to be paid on time if that is not the case, they can push for a management take over or institute liquidation procedures against the company (Loughran, 2011).
References
Loughran, M. (2011). Financial accounting for dummies . Hoboken, NJ: Wiley.
