7. Creating Balance Sheet Assumptions Part 2

Overview

In this lesson, we create additional balance sheet assumptions for both non-current assets and liabilities. I also discuss the reasoning behind each of my assumptions.

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Summary

  1. Lesson Goal (00:04)

    The goal of this lesson is to create assumptions for non-current assets and non-current liabilities.

  2. Assumptions for Non-Current Assets (00:18)

    MarkerCo’s Balance Sheet contains three non-current assets. The first is Property, Plant and Equipment. If we have created a depreciation and capex schedule, then we know what the future value of PP&E will be in each future year, so we don’t need to create an assumption. This is the case in our financial statements.

    Second is long-term investments. In our financial statements, this has remained constant in previous years, so we assume it will remain constant in the future.

    Third is other non-current assets. It can be difficult to create an assumption for a value like this, because we can’t be sure what kind of assets are included in this value. In our case, we calculate the Compound Annual Growth Rate from the first year to the last year of our historic values. We then assume this growth rate will be maintained each year in the future. This is a useful strategy for assets that are growing but not tied to any particular operating metric.

  3. Assumptions for Non-Current Liabilities (02:34)

    There are two non-current liabilities in our Balance Sheet. First is other non-current liabilities. In our case, these have stayed constant in recent years, so we assume they will remain constant in the future.

    Second is deferred tax liabilities. We can assume this will be a percentage of the income tax expense. As a result, we create a historical assumption by dividing deferred tax liabilities by the income tax expense for each historical year in our financial statements.

  4. Assumptions for Equity (03:52)

    The Equity section of the Balance Sheet contains two entries. First is Issued Share Capital. This will change if new stock is issued in the future. In our case, this has remained constant in recent years, and management have not stated any intention to issue new shares. As a result, our assumption is that this will remain constant.

    Second is accumulated earnings. This will rise every year based on the net profit for that year. As a result, there is no need to create an assumption for this value, as we can simply calculate it using a formula.

Transcript

In the previous lesson we created assumptions for our current assets and current liabilities, In this lesson we are going to look at non current assets and non current liabilities. So I'll skip down to the Balance Sheet and take a look firstly, at non current assets. The first of these is Property, Plant and Equipment. From our Depreciation and Capex schedule, we already know what future PP and E will be up to 2020, so there's no need for us to create a future assumption for this non current asset. Next up, are the long term investments. And because this balance hasn't changed over the previous 4 years I'm going to assume that the company will not make any long term investments for the next 5 years. So I'll simply write 0.6 for each of these years.

Other non current assets however have shown an increase over the past 4 years. And we'll need to apply an assumption for this particular value. It's not easy to predict what other not current assets entail. Unless included in the notes to financial statements. But they are unlikely to be tied to the operations of the business. For example they could include pension assets. For assets like this that are growing but are not tied to any operating matrix, I tend to use something like a compound annual growth rate for historic values to apply to my future projections. So let's do this in my assumptions table. To calculate CAGR I take, firstly the end value, which would be 3.7 divided by the start value, which would be 1.4, and that's all to the power of one divided by the number of years. Which in this case is three.

Then I subtract minus one.

This gives me my compound annual growth rate of 38.3%.

And I'll assume that this stays constant for the next 4 years. So I'll copy with control C, and paste as values, Alt + E S V.

With non current assets now finished let's move to liabilities.

Other non current liabilities have stayed constant over the last 4 years, and assume that they stay constant as well for the next 5 years.

Defer tax liabilities, as you can imagine, are dependent on our income tax expenses. So I'm going to create an assumption for the deferred tax liabilities projection. Again scrolling up to my assumptions.

In the past I'll check defer tax liabilities.

Full divided by income tax expense.

And copy across for each year.

And based on these percentages I'll be able to make my Balance Sheet projection. Defer tax liabilities are the last line in our non current liabilities on the Balance Sheet.

But what about equity? The shareholders equity will change if we project that Marco co. Will issue new stock in the future. Given that the company has not issued new stock in the past 4 years and management have not intimated that they need to do so, let's assume that no new stock is issued in the future, so no new projection is needed here. Accumulated earnings on the other hand will increase over time, but by adding net profit each year to our existing accumulating earnings, as a result we don't need to provide a projection for this cell. It will be calculated off a formula. We now have the projections for all of the entries on the Balance Sheet that we need. So let's build these projections in the next lesson.