ACCOUNTING VERSUS FINANCIAL BALANCE SHEETS

When analyzing a firm, what are the questions to which we would like to know the answers? A firm, as defined here, includes both investments already made—assets in place—and investments yet to be made—growth assets. In addition, a firm can either borrow the funds it needs to make these investments, in which case it is using debt, or raise it from its owners in the form of equity. Figure 9.1 summarizes this description of a firm in the form of a financial balance sheet.

Note that while this summary does have some similarities with the accounting balance sheet, there are key differences. The most important one is that here we explicitly consider growth assets when we look at what a firm owns.

When doing a financial analysis of a firm, we would like to be able to answer a number of questions relating to each of these items. Figure 9.2 lists the questions. As we see in this chapter, accounting statements allow us to acquire some information about each of these questions, but they fall short in terms of both the timeliness with which they provide it and the way in which they measure asset value, earnings, and risk.