This post is the fifth installment in a series on Measuring Value Creation. Key to the equation is knowing the Amount Invested. A Balance Sheet, among other things, is the vehicle for tracking the Amount Invested in a business unit, but to put this into context requires an explanation of the Balance Sheet.
Yesterday’s post dove into the first section of the Balance Sheet-Assets. We learned that Assets are a measurement of the value of a business. However, the measurement that is reflected on the balance sheet is derived using GAAP. The true value of the business is referred to as Intrinsic Value, which is an estimate of what an enterprise’s free cash flows, appropriately discounted, are really going to be. More times than not, Asset Value and Intrinsic Value can be quite different values from one another. Intrinsic Value is based on future events, and reasonable people can have different opinions of the future. Accountants don’t like uncertainty and therefore the Balance Sheet uses GAAP to determine the Asset Value.
The next item on the Balance Sheet is Liabilities. A homeowner with a mortgage owes money to a bank. Similarly, Zayo owes money to others. It owes banks a certain amount of money. It also owes money to utilities for the long term use of certain fiber assets-and these are reflected as capital leases on the balance sheet. Liabilities capture the portion of the Asset value that belongs to those holding the debt. This is no different than the mortgage that remains on your house.
Note that, unlike Assets, Liabilities that are carried on the Balance Sheet are usually an accurate depiction of what is really owed to third parties. If you run a business, or a business unit, you should be very aware of the Liabilities that are carried on your Balance Sheet. A later post in this series will show how Liabilities factor into the Value Creation equation.
Finally, the Balance Sheet contains Owner’s Equity, which means the value of Assets that belongs to the equity holders instead of those holding the debt. Said differently, the Assets belong to one of two groups: Debt Holders or Equity Owners. The Liability section of the Balance Sheet shows the portion of the Assets that belong to debt sponsors. Everything else belongs to the Shareholders. In equation form, Owner’s Equity = Assets Minus Liabilities.
In the next post, we will break down the Owner’s Equity portion of the Balance Sheet. When we do so, we will learn how to track Amount Invested.
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