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analyse balance sheet

How To Analyse Balance Sheet For eCommerce Business?

E-commerce is a business model that allows firms and individuals to conduct business over an electronic network. Today, nearly every imaginable product and service is available through e-commerce transactions.

One form of e-commerce business is the one that serves online content in the form of news, proprietary information, and knowledge. Another form of e-commerce is the sale of goods and services through the Internet. This may include business-to-business (B2B) and business-to-consumer (B2C) sales of products and services. 

Thus, B2B or B2C e-commerce businesses may require companies to customize their business models to capture sales online. Such business models may require companies to build out distribution channels such as warehouses, web pages, and product shipping centers.

Thus, e-commerce significantly changes the way business is conducted. In particular, e-business requires a business to change its organizational structures, how partnerships and alliances are developed, delivery mechanisms, and regulations under which businesses operate.

These fundamental changes also lead to changes in the accounting records maintained and accounting procedures followed. 

In this article, we will learn what a balance sheet is and how to analyze the balance sheet of an e-commerce business. 

What is a Balance Sheet?

The Balance sheet is the statement of the financial position of a business. This is one of the three basic financial statements ​​showcasing elements that directly relate to the measurement of the financial position of a business.

The elements that directly relate to the financial position of a business include assets, liabilities, and equity. All these elements inform the stakeholders of a business what it owns and owes to the third parties on a specified date. Also, such a financial statement shows the business entity’s liquidity position and capitalization.

The balance sheet provides a snapshot of a business’s financial position on a specified date. Typically, it is either the end of a year or a quarter.

Balance Sheet Formula: Accounting Equation

The economic resources it controls affect the financial position of an e-commerce business, just like any other business. Furthermore, the entity’s financial structure, liquidity and solvency, and capacity to adapt to environmental changes also impact the financial position.

For instance, the information about an entity’s economic resources and capacity to modify them helps determine its ability to generate Cash and cash equivalents. Likewise, information about the entity’s liquidity and solvency helps determine an e-commerce business’s ability to meet its financial commitments as they fall due. 

As mentioned earlier, assets, liabilities, and equity are the elements directly related to the measurement of financial position in the balance sheet. Accordingly, the following is the fundamental accounting equation or balance sheet equation or balance sheet formula:

Assets = Liabilities + Owner’s Equity

Every dollar an e-commerce business invests toward its assets isis provided by its owners or creditors. 

Thus, the assets of an e-commerce business are the economic resources that provide benefits in the future. These indicate the funds the business utilizes to acquire resources to earn profits. 

On the other hand, the liabilities and owner’s equity of an e-commerce business are the claims against it. Liabilities refer to the amounts an e-commerce business owes to outside parties such as banks, creditors, vendors, etc. At the same time, owner’s equity refers to the claims that an e-commerce business has to receive from outside parties. In other words, the liabilities of an e-commerce business represent the sources through which funds are raised. 

How To Analyse the Balance Sheet of an E-Commerce Business?

A business must understand the components showcased in the financial statement to analyze the balance sheet. The following are the various balance sheet items that help represent a business’s financial position, including an e-commerce business.

1. Assets

An asset refers to a resource that an e-commerce business controls as a result of the events that occurred in the past. The business holds such resources as it is expected that the economic benefits will flow to the business shortly.

An asset’s characteristic of generating future economic benefit means it has the potential to contribute to the flow of Cash and cash equivalents to the entity either directly or indirectly. Such potential may take the form of earning profits through the operating activities of a business. 

It may also take the form of reducing production costs as a result of an alternative and efficient manufacturing process in place. An asset’s characteristic of generating future economic benefit may also take the form of the level of liquid assets that a business has. That is, a business has sufficient liquid assets which can be converted into Cash or cash equivalents.

Accordingly, to analyze the balance sheet of an e-commerce business, the following are the key components of a balance sheet that one must know.

(a) Current Assets

The Current Assets are the assets that can be consumed or converted into Cash within the normal operating cycle of a business or one year, whichever is longer. The operating cycle of a business refers to the amount of time it takes to buy or produce inventory, sell the finished products, and collect Cash for the same.

The operating cycle of an e-commerce business is typically low as it takes fewer days to make a sale. For instance, ‘Zapin’ is an e-commerce store selling consumer products. One of the products that it sells is ‘Creme’ body soap. Say it takes ‘Zapin’ 1 day to make a sale, 1 day to collect the amount, and 1 day to pay the supplier ‘Creme’; the operating cycle would be 1+1-1 = 1 day.

For certain manufacturing businesses, the operating cycle may be one year or more than a year. 

Now, the current assets of a business may include Cash, marketable securities, accounts receivable, inventories, and prepaid expenses.

(i) Cash

The most liquid of all current assets of a business is Cash. Thus, maintaining Cash is important for a business to maintain its short-term solvency. That’s because cash balance is readily available with the business. A business can use the available Cash instantaneously to meet its day-to-day expenses.

The cash balance in the e-commerce balance sheet is shown as the first item under the current assets on the right-hand side. It typically includes coins, currencies, funds on deposit with a bank, cheques, and money orders.

(ii) Marketable Securities

The next set of current assets is Marketable securities. Marketable Securities refer to investments expected to be converted into Cash within a year. Plus, such types of investments are easily marketable. An e-commerce business may invest in marketable securities like treasury bills, notes, bonds, and equity securities.

These investments are the external investments that an e-commerce business may make. There are two reasons why a business may hold external investments. Either it has access to excess Cash or accumulates Cash to make a larger purchase. External short-term investments in equity or debt instruments are held to earn capital gain or income.

(iii) Accounts Receivable

Accounts receivables refer to the outstanding amounts a business’s customers owe for the goods and services the company supplies on credit. These are represented at the net realizable value in an entity’s balance sheet. 

The net realizable value of the account receivable is the amount we get after deducting the bad debt expense from the total outstanding accounts receivable.

In the case of an e-commerce business, the accounts receivable include the net amount related to customers, vendors, and sellers. 

(iv) Inventories

Inventories refer to the stocks of goods owned and under the business owner’s control. An e-commerce business typically follows the dropshipping model. In this model, the e-commerce orders are sent to the supplier that manages the stock and handles the order delivery. 

In this case, the retailer receives the e-commerce order and sends it directly to the supplier. The supplier is the one who decides on his own the quantities to be manufactured. Further, it is his responsibility, not the retailer’s, always to maintain stock of goods.

Thus, if the e-commerce store runs on the dropshipping model, it will not include the inventories that the third-party supplier maintains. It will only maintain its inventory and sell it to the end customers. 

It is important to note that the items that form a part of the inventory are the goods that would be sold normally. In the case of merchandising companies, goods available for resale form a part of the inventory. Whereas, in the case of manufacturing firms, goods available as raw materials, work-in-process, and finished goods form a part of the inventory.

(v) Prepaid expenses

Prepaid expenses refer to the operating costs of a business that have been paid in advance. Since such expenses have been paid in advance without receiving the goods or services, they act as assets for the business. That’s because the business is yet to receive the economic benefits. 

When expenses are paid in advance, that is, at the beginning of the accounting period, at such a time, the Cash reduces in the balance sheet; simultaneously, a current asset of the same amount is created in the balance sheet by prepaid expenses.

(a) Fixed Assets

The Fixed assets of a business are the long-term assets acquired in past transactions for producing goods or providing services. Such assets are not acquired to resell them to earn profit. These assertion-current assets are not readily convertible into Cash in normal operations.

This means the fixed assets have more than a year of useful life. They are either tangible or intangible.

(i) Tangible Fixed Assets

The Tangible Fixed Assets are the physical assets that can be measured. Further, a business entity uses such assets to conduct its operations, like providing services. Tangible Fixed Assets include Property, Plant and Equipment, and Long Term Investments.

The first head under Tangible Fixed Assets is Property, Plant, and Equipment, the long-term tangible assets that a business acquires to carry out business operations. An e-commerce business’s Property may include land and building that the business owns. It may also include property acquired under build-to-suit lease arrangements when the e-commerce business controls it during the construction period and finance lease agreements.

An e-commerce business’s equipment may include servers, networking equipment, heavy equipment, and other fulfillment equipment. Note that the Fixed Assets are stated after considering the accumulated depreciation and amortization.

The Tangible Fixed Assets may also take the form of long-term investments. These investments typically refer to internal investments in debt securities or equity. Such investments may be in subsidiaries, associates, and joint ventures. Besides this, a business may also invest in real estate and Cash. These investments are long-term, held by the business entity for more than one year.

(ii) Intangible Fixed Assets

Intangible assets are the non-physical assets a business utilizes over a long period. These include Patents, Copyright, and Goodwill.

Copyright refers to the exclusive right that the owner of the work has. Such a right stops any competitor from copying or imitating the owner’s original work owner. Since its an intangible asset, it is amortized over some time.

Likewise, intangible fixed assets may include a patent. The patent refers to the statutory right for an invention granted to the investee for a limited period. Such a right is given by the government in exchange for full disclosure of the invention by the patentee. Thus, a Patent excludes others from using the product or invention of the patentee in any form without his consent. Since a patent has a limited useful life as an intangible asset, it is recorded at cost in the balance sheet.

Goodwill is an intangible asset that arises when the purchasing company pays more for the acquired company than the fair value of its net assets. The difference between the purchase price and the fair value of the net assets is recorded as an asset of the acquiring company.

2. Liabilities

Liabilities are the present obligations of a business. An obligation refers to the duty or responsibility of the business entity to act or perform in a certain way. Such obligations may be legally enforceable due to a binding contract or statutory requirement. For instance, a contract with trade creditors, lenders, and equity owners against the entity’s assets. 

Note that an obligation occurs only when an asset is delivered or the business enters an irrevocable agreement to acquire the asset. A decision to acquire assets in the future does not give rise to a present obligation.

Further, a business can settle these present obligations in different forms, depending upon the contract terms entered into. These may include payment of Cash, transfer of assets, service provisions, replacement with another obligation, or conversion of an obligation into equity.

Now, the liabilities of a business are further grouped into current liabilities and Other Liabilities.

(a) Current Liabilities

Current liabilities are expected to be met or satisfied within the normal operating cycle of the business or one year, whichever is longer. Here, the operating cycle refers to the period between goods purchased for manufacturing and the receipt of Cash from selling the final goods.

An e-commerce business may have current liabilities in bills payable, accrued expenses, and deferred revenues.

Accounts payable are the amounts a business entity owes to its suppliers for goods or services purchased on credit. These amounts occur between receipt of services or acquisition to the title of goods and payment for such supplies. Credit on accounts payable can be extended typically for 30 days or 60 days.

Another current liability includes accrued expenses. These are the expenses that are not contractually due. But a business incurs or recognizes such expenses in its income statement. This means an e-commerce business has yet to pay Cash for such expenses. However, it recognizes such expenses in its income statement as it has already received the benefit against them.

Likewise, unearned revenues also form a part of the current liabilities of a business. These revenues are the amounts that a business collects in advance to provide goods or services to its customers. In other words, a business entity receives the payment in advance. But it is yet to deliver the goods or services to its customers.

Such an advance payment means the seller has a liability equal to an amount of revenue generated in advance until actual delivery is made.

(b) Other Liabilities

Other liabilities do not fall under the current liabilities. Such non-current liabilities are the financial obligations of a business that remain outstanding for more than a year. For instance, long-term debt, deferred tax liabilities, and long-term provisions all fall under Other Liabilities.

Long-term debt refers to the loans a business entity avails of from a bank, financial institution, or indigenous lenders. Such loans are payable after 12 months with interest. For instance, bonds, debentures, and long-term borrowings come under long-term debt.

A business entity takes such a debt to meet its capital needs and to ensure the proper functioning of the business operations. 

(c) Deferred Tax Liabilities

Businesses pay tax as per the profits earned in a particular financial year. However, there can be situations when the business pays taxes less than it was liable to pay. 

Thus, a business must pay unpaid taxes for a given year in the next financial year. Such a tax shortfall is the deferred tax liability in the given financial year. This becomes payable in the next financial year and year’s tax.

(d) Long-Term Provision

Long Term Provisions refer to the amount kept aside to cover a future liability or decrease in the value of an asset. Such a provision is not a saving. Rather, it is an acknowledgment in advance of a liability that may arise in the future.

3. Owner’s Equity

The owner’s equity is the third head in the balance sheet. It is the amount invested by the investors in the e-commerce business. The owner’s equity is further divided into paid-in capital and retained earnings.

Owner’s Equity = Paid-In Capital + Retained Earnings

Thus, an increase in income or earnings of the business increases the owner’s equity. At the same time, a decrease in earnings of the business decreases the owner’s equity.

Balance Sheet Format

Following is the balance sheet of Amazon as of December 2020.

Consolidated Balance Sheet of Amazon Inc As Of December 31, 2020

(Amount in Million Dollars)
Assets Amt  Liabilities Amt
Current Assets   Current Liabilities  
Cash and Cash Equivalents 42,122 Accounts Payable 72,539
Marketable Securities 42,274 Accrued Liabilities 44,138
Inventories 23,795 Unearned Revenue 9,708
Accounts Receivable 24,542    
Total Current Assets 132,733 Total Current Liabilities 126,385
Non-Current Assets   Non-Current Liabilities  
Property, Plant, Equipment Net 113,114 Long-Term Lease Liabilities 52,573
Operating Leases 37,553 Long Term Debt 31,816
Goodwill 15,017 Other Long-Term Liabilities 17,017
Other Assets 22,778 Commitments & Contingencies
    Total Liabilities  
    Owner’s Equity  
    Preferred Stock  
    Common Stock 5
    Treasury Stock at Cost (1,837)
    Additional Paid-In Capital 42,865
    Accumulated Other Comprehensive Income (Loss) (180)
    Retained Earnings 52,551
    Total Owner’s Equity 93,404
Total Assets 321,195 Total Liabilities and Owner’s Equity 321,195
Image Source: sec.gov

Recognition Of Assets In the Balance Sheet

A business recognizes an asset in the balance sheet only when it is likely that future economic benefits will flow to the entity from such an asset. Besides this, such an asset has a cost or a value that can be measured reliably.

On the other hand, the business may not recognize an asset in the balance sheet when it is unlikely that such an expenditure would render economic benefits beyond the current accounting period. In such a case, a business entity may recognize the expense of acquiring such an asset in the income statement.

This does not mean that the management’s intent in incurring such expenditure was other than to generate future economic benefits for the entity. Neither does this mean that the entity’s management was misguided regarding making such an expense?

It simply means that the certainty that economic benefits will flow to the entity beyond the current accounting period is insufficient. It is insufficient enough for the business entity to recognize the expenditure as an asset.

Recognition Of Liabilities In Balance Sheet

A business entity may recognize fund outflow as a liability in the balance sheet when it is likely that such outflow of resources will settle the present obligation. In other words, the economic benefits will flow to the business in the form of the current obligation getting settled. 

Further, to recognize a resource outflow as a liability, it must be possible for the entity to measure the amount at which the settlement takes place reliably. 

On the other hand, there is a possibility that a business entity has certain obligations under contracts that are equally proportionately unperformed. For instance, liabilities arise from ordered inventory not yet received by the entity. If such a situation arises, the entity will not recognize such a transaction as a liability in the balance sheet.

But if an obligation meets the criteria for liabilities and recognition of such liabilities, then it may qualify for recognition in the balance sheet. In such circumstances, recognizing liabilities necessitates recognizing related assets or expenses in the financial reports.

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