Analyzing a Sample Balance Sheet - Microsoft

Investing Lesson 3 - Analyzing a Balance Sheet

Microsoft Logo

The main purpose of balance sheet analysis is to determine if a company is financially strong and economically efficient. The first balance sheet we are going to look at is a perfect example of both. It can be found in Microsoft's 2001 10K statement.

A Quick Note on Microsoft's Balance Sheet

Before we begin analyzing, notice that unlike most balance sheets, the most recent year is on the right-hand side in bold.

I highlighted the column so you would be sure to look at the correct figures.

An additional point: when companies put together their balance sheet, they tend to omit the 000's at the end of long numbers to save space. If you see on the top of a balance sheet that numbers are stated "in thousands", add "000" to find the actual amount (i.e., $10 stated in thousands would be $10,000). If a balance sheet is stated in millions, you will need to add "000,000" (i.e., $10 stated in millions would be $10,000,000).

Keep in mind we are analyzing the fiscal balance sheet as of June 2001. This information may be different when you go to search on Moneycentral, Yahoo!, or TheStreet since they will use the most recent data available. The purpose of this analysis is not to advise you on what to buy, but rather to show you the process of analyzing a balance sheet.

Let's Begin Analyzing!

Cash Position

The first thing you will notice is that Microsoft has $31.6 billion in cash and short term investments.

This doesn't mean much unless you compare it to the company's debt to find out if it is borrowed money. Glance down the balance sheet and look for any long-term debt. You'll notice there isn't an entry for it. This isn't a mistake; Microsoft has no long term debt.

Don't get too excited yet. Remember that some businesses fund day-to-day operations with short-term loans (think back to our department store executive at Christmas in Part 10).

To see if Microsoft is using short term debt to survive, look at the current liabilities. In 2001, the entire value of Microsoft's current liabilities was $11,132. Compare that to the $31.6 billion in cash the company has. Does it have enough money to pay off its debt? Absolutely. Microsoft's balance sheet has 3x the cash necessary to pay off current liabilities and long term debt. This is without calculating in receivables and other assets. You can be sure the company is not in any danger of going bankrupt.

Working Capital

Let's calculate the company's working capital. Take the current assets ($39,637) and subtract the current liabilities ($11,132). The answer is $28,505. Microsoft has $28.5 billion in working capital. To find the working capital per share, look at the bottom of the balance sheet. You'll see there are 5.383 billion shares outstanding. Take the working capital of $28.5 billion and divide it by the 5.383 billion shares outstanding. The answer, $5.29, is the amount of working capital per-share.

If you could buy Microsoft's stock at $5.29 per share, you would be getting all of the company's fixed assets (real estate, computers, long term investments, etc.) plus its earnings / profit each year from now until eternity for free!

The company will probably never trade that low, but you should always keep this in mind when analyzing a business. Sometimes, especially during serious economic downturns, you will find companies selling close to working capital. (Note: We will discuss stock option dilution and other advanced concepts in later lessons.)

Working Capital Per Dollar of Sales

We calculated working capital at $28.505 billion. According to Microsoft's income statement, total revenue (the same thing as total sales) came to $25.296 billion. Following the formula for Working Capital per Dollar of Sales, we come up with 1.12 (or 112%). This means Microsoft has more working capital than its sales last year; if you remember from the lesson, manufacturers of heavy machinery require the most working capital and range from 20-25%.

The 112% figure is excessive by anyone's standard. The main concern should not be financial safety, but efficiency. Why isn't Microsoft putting this money to work?

Current Ratio

The current ratio should be at least 1.5 but probably not over 3 or 4. Taking Microsoft's current assets and dividing them by the current liabilities, we find the software company has a current ratio of 3.56. Unless the business is saving resources to launch new products, build new production facilities, pay down debt, or pay a dividend to shareholders, a current ratio this high usually signals that management is not using cash very efficiently.

Quick Ratio

To calculate the quick ratio, we have to take the quick assets and divide them by current liabilities. If you've studied Microsoft's current assets, you will notice there is no entry for inventory. You know that Microsoft sells software; meaning its products consist of information It doesn't need to carry inventory. As soon as a customer places an order, the company can load its program onto a CD-ROM or DVD and ship it out the same day. Because there is no inventory, there is no risk of spoilage or obsolesce.

Inventory is what causes the biggest difference between the current and quick ratio. The quick ratio was designed to measure the immediate resources of a company against its current liabilities. Almost all of Microsoft's resources are already liquid. The only things that aren't are the $1.949 billion in deferred income taxes (how are you going to use it to raise cash?) and the $2.417 billion attributed to "other" current assets. Subtract these from the $39,637 billion in current assets and you get $35.271 billion. This $35 billion in quick assets represents the things the company can turn in to cash almost immediately. Divide it by the current liabilities ($35.271 divided by $11,132) and you get 3.168. Even under the most stringent test of financial strength, Microsoft has $3.168 in current assets for every $1 in liabilities.

Microsoft's Financial Sheet Excerpts

Microsoft's Balance Sheet
- January 31, 2001
In Millions
Cash and equivalents$4,846$3,922
Short-term investments$18,952$27,678
Total cash and short-term investments$23,798$31,600
Accounts receivable$3,250$3,671
Deferred income taxes$1,708$1,949
Total current assets$30,308$39,637
Property, Plant and Equipment, Net$1,903$2,309
Equity and other investments$17,726$14,141
Other assets$2,213$3,170
Total assets$52,150$59,257
Accounts payable$1,083$1,188
Accrued compensation$557$742
Income taxes$558$1,468
Unearned revenue$4,816$5,614
Other liabilities$2,714$2,120
Total current liabilities$9,755$11,132
Deferred income taxes$1,027$836
Common stock and paid-in capital$23,195$28,390
Retained earnings, accumulated other comprehensive income of $1,527 and $587$18,173$18,899
Total stockholders' equity$41,368$47,289
Total liabilities and stockholders' equity$52,150$59,257


Microsoft's Income Statement
- January 31, 2001
In Millions, except earnings per share
Year Ended June 30
Cost of Goods Sold