Balance Sheet Comparison Amongst Business Peers-Intrinsic Viewpoint

The common practice in Accountancy when assessing the viability of a business is giving a focus on the financial position of a business. If it is appealing, we conclude that all is well and the future of the business is assumed prosperous. This proposition may take a different dimension if we consider the intrinsic financial position of a business

Balance sheet of a business represents the financial position of that business at a particular period. Therefore, from look of things, if two or more balance sheets of different organizations have the same face value (nominal) financial position, it implies that those firms are at par in the economy. Then, the next one million dollar question is whether those balance sheets represent the same intrinsic financial position in the future for the firms under investigation.

 

Definition: Intrinsic value of an organization is the Present Value (PV) of all expected future cash flows discounted at the correct discount rate.

Similarly, we can define intrinsic financial position of a balance sheet to mean the present value of future cash flows an asset is expected to generate using the appropriate discounting rate. This implies that although two all more balance sheets may apparently be the same, the future financial position will be determined by the investment asset(s) selected by the owner of the business.

 

Therefore, the financial position of two or more business peers may be the same on the face value. But, the intrinsic value may vary. This is because the idea adopted by the entrepreneur determine the growth rate of the investment focused on.

Illustration  

Let us look at a case of three balance sheets of three entrepreneurs, namely; Peter John and Ericson

 

Discussions

The balance sheets of the three investors are the same in terms of financial position is concerned. The cost value of the non-current assets acquired are the same, but the intrinsic value of those three non-current assets, namely; public service motor vehicle, juice processing machinery and water bottling machinery. That is, the cash flows each machinery is able to generate in future is different. For example, based on the demand level of transport services, fruit juices and drinking water, the ranking of demand level can be as follows;

 

 

Product                        Rank

Transport services           1st

Drinking water                  2nd

Fruit juice                         3rd

This implies that the balance sheet whose investment asset is represented by transport motor vehicle will have a higher intrinsic financial position in future, followed by the secondly ranked balance sheet and thirdly the balance sheet with fruit juice machinery used for investment.

Example

The balance sheet of High, Moderate and Low temperature limited companies were as shown below;

 

The expected future cash inflows for the next four years for the three types of investment was as follows

 

 

Additional information

The discounting rate for the three years was constant at 10%

Required

Determine the intrinsic financial position of the three companies and rank them from the most to the least profitable investments

Solution

Computation of the present value of the future cash flows for the three machinery

Formula for Present Value is

The ranking index based on present value for the three non-current assets were as follows;

Product                       Rank

Covid-19 lab test             1st

Sawing services              2nd

Road construction           3rd

 

In conclusion, the covid-19 affiliated balance sheet will have the highest intrinsic financial position followed by sawing machine and construction related balance sheet as ranked above.

About the Author - Dr Geoffrey Mbuva(PhD-Finance) is a lecturer of Finance and Accountancy at Kenyatta University, Kenya. He is an enthusiast of teaching and making accounting & research tutorials for his readers.