Purpose of a balance sheet
A balance sheet is one of the financial statements that a business prepares to reveal the financial status of an organization as of a certain point in time. It shows the firm’s assets which is what the business owns, its liabilities which is how much it owes and its equity which represents the total amount invested into the entity (“The purpose of a balance sheet | Chase for Business”, 2022).
From the balance sheet analysis, one can establish the entity’s financial health and standing (“The purpose of a balance sheet | Chase for Business”, 2022). For example, one can compare current assets to its current liabilities to see if the company can meet its short-term obligations as they fall due. Also, one can compare it performance against competitors by comparing ratios such as debt to equity ratio and quick ratio. In addition, it acts as a support document to an existing or potential review by investors on entity’s net worth.
John Deere Company balance sheet analysis
Looking at the trend analysis of the balance sheet, we can see that total current assets increased from 2020 to 2021 from $52,581 million to $59,957 million which is a 14.03% increase. There was also an increase in current liabilities from $23,481million in 2020 to $27,872 million in 2021. The shareholders equity stands at $18,434 million in 2021, a 42.41% increase from 2020 where it stood at $12,944million.
Financial ratios assist us to understand the company’s financial standing. They are easy to understand and can be used to compare performance of different entities regardless of the size and industry.
The main ones are the current ratio and the quick ratio. The current ratio is computed as current assets over current liabilities which derives a current ratio of 2.15 and 2.24 in 2021 and 2020 respectively. This is above the recommended healthy current ratio of 1.5. It means that the company has 2.15 dollars for every dollar in current liabilities, therefore, it can meet its short-term obligations.
The quick ratio is computed by subtracting inventory from current assets then dividing by current liabilities. The ratio is 1.91 and 2.03 in 2021 and 2020 respectively. It can be interpreted as having 1.91 dollars quick assets in 2021 for every current liability dollar. The recommended industry ratio is 1. The higher the ratio the better for the business. It means the company is in a healthy liquidity position.
The receivables turnover and inventory turnover are the two key ratios that measures the asset utilization of the firm. The inventory turnover is the cost of goods divided by inventory which gives ratios of 4.94 and 4.32 in 2021 and 2020 respectively. It is above the industry average of 4 which means that the company can sell its goods quickly meaning the demand is high (Furhmann, 2021).
The receivables turnover is derived as net sales divided by the average account receivables. The ratio is 9.48 and 5.72 in 2021 and 2020 respectively. The ratio is above the industry average of 7 which means that the business collection process is efficient and has a high-quality customer base as at 2021.
Long term solvency
We shall compute the total debt ratio and debt to equity ratio to evaluate the long-term solvency status for the entity. The total debt ratio is measured as total liabilities divided by total assets. It gives a ratio of 0.78 and 0.83 in 2021 and 2020 respectively. Since the firm’s debt ratio is above 0.5, the industry benchmark in both years, it means that the business is highly leveraged. Most of its assets are financed through debt and not equity. It could make it hard for the firm to borrow more money in the future.
On the other hand, the debt to equity ratio is computed as total debt divided by total shareholders’ equity. This gives a ratio of 3.56 and 4.80 in 2021 and 2020 respectively for Deere and Company. It shows the company’s equity ability to cover all debts in case of firm’s downturn. Since its higher than the industry benchmark of 1, it is a high risk for the business as it means the company relies on debt more for its growth.
The return on assets is a good indicator of the company’s profitability level. It is computed as net income divided by the total assets. It indicates the amount of profit a business makes per dollar of assets. The net income is $5,963 million in 2021 and $2,751 million in 2020 while total assets are $84,114 million and $75,091 million in 2021 and 2020 respectively. The ROA for 2021 and 2020 becomes 0.07 and 0.04 respectively. This means that for 2021, for every invested dollar in assets, there is $.07 cents in net income which is above industry benchmark of 5%. It translates to efficiency in profit generation thou there is a room for improvement s the higher the ratio the better for the entity.
Deere and Company is in a healthy liquidity position. However, there is a threat to the company long term solvency since it relies hugely on debt financing. It should ensure the debt is being used to grow and boost earnings for the business to guarantee its going concern. The business should also focus on improving its profitability as the higher the ROA, the better as it means the firm is efficient in generating profits.
Forbes.com. (2022). Understanding Return on Assets (ROA) https://www.forbes.com/advisor/investing/roa-return-on-assets/#:~:text=An%20ROA%20of%205%25%20or,company%20is%20at%20generating%20profits.
Furhmann, R. (2021). How to Calculate the Inventory Turnover Ratio. Investopedia https://www.investopedia.com/ask/answers/070914/how-do-i-calculate-inventory-turnover-ratio.asp.
The purpose of a balance sheet | Chase for Business. Business.chase.com. (2022). https://business.chase.com/resources/start/the-purpose-of-a-balance-sheet#:~:text=A%20balance%20sheet%20gives%20you,evaluate%20their%20company’s%20financial%20standing.