# Analyzing a Sample Balance Sheet From Microsoft

The main purpose of balance sheet analysis is to determine if a company has financial strength and economic efficiency. The first balance sheet mentioned here shows 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.

This column is highlighted to help you focus on the correct figures.

An additional point: when companies put together their financial statements, they tend to omit the 000's at the end of long numbers to save space. If you see at 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 you are analyzing the fiscal balance sheet as of June 2001. This information will 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.

### 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.

Remember that some businesses fund day-to-day operations with short-term loans.

To see if Microsoft uses 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 doesn't include receivables and other assets. You can be sure the company has no danger of going bankrupt.

### Working Capital

Calculate the company's working capital. Take the current assets (\$39,637) and subtract the current liabilities (\$11,132). You'll arrive at an answer of \$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. You'll find that Microsoft has \$5.29 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 for close to working capital.

### 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 percent).

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 percent. The 112 percent figure is excessive by anyone's standards. 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 does not use its cash very efficiently.

### Quick Ratio

To calculate the quick ratio, take the quick assets and divide them by current liabilities. If you've studied Microsoft's current assets, you will notice it has 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 the company has no inventory, it also has no risk of spoilage or obsolescence.

Inventory levels cause 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 into 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, 2001In Millions 2000 2001 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 Other \$1,552 \$2,417 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, 2001In Millions, except earnings per share Year Ended June 30 1999 2000 2001 Revenue \$19,747 \$22,956 \$25,296 Cost of Goods Sold \$2,814 \$3,002 \$3,455