We find out what analysts want from a balance sheet and how they use the data, so you know how best to present the numbers.

What information do analysts and investors expect when they assess a company’s balance sheet?

The answer can inform how assets and liabilities should best be presented, and indicate the importance (or otherwise) of measuring assets at fair value.

The best way to find out what information analysts value is to ask them. In late 2006 PricewaterhouseCoopers met buy and sell-side investment professionals in Boston, London and New York, as well as some investors based in San Francisco, Frankfurt and Toronto.

The results are captured in PwC’s report, Measuring Assets and Liabilities – Investment Professionals’ Views.

The findings show that support for measuring assets and liabilities at fair or current value depends on the asset or liability in question.

Survey respondents were satisfied with the use of current value measures for highly liquid financial assets, but were generally concerned about their use for illiquid assets and many liabilities.

“The biggest concern we heard was when it comes to using fair value for operating assets,” says Alison Thomas, a director in PwC’s corporate reporting team.

“It’s critical that analysts get a clean view of the operating performance of the company.”

Changes arising from marking to market could cloud that view, particularly because they are not necessarily under management’s control and therefore are irrelevant to an assessment of management’s performance.

Ralf Frank, managing director of the Society of German Investment Professionals, believes analysts understand the concept of fair value.

But he says: “For balance sheet items for which you don’t have a market value, that’s where it becomes really tricky. It opens the door for all sorts of estimates.”

Therefore companies need to disclose clearly any assumptions they make when valuing balance sheet items. “You have to add explanations to show how you arrive at these figures,” Frank says.

Thomas agrees that detail on how valuations are reached is essential. “The more you are using models to value an asset, the more you need to have transparency in terms of the assumptions going into that model,” she says.

“Analysts would like information so as to be able to normalise those assumptions so they can compare and contrast companies.”

Take pensions liabilities, which may be based on different assumptions about mortality rates. Analysts need to see these differences and be able to perform their own back-of-envelope calculations to view accounts on a comparable basis.

Some analysts may require a lot of detail. “They want granularity,” Frank says.

“They want to look at an item on the balance sheet and be able to dig down to the constituent elements, until the reason for this number has been solved.”

To provide such granularity efficiently, Frank advocates considering the use of XBRL, the electronic language for financial reporting.

“XBRL gives the user the possibility in an electronic way to find the constituent components he or she needs,” he says.

Analysts’ needs will often vary depending on the balance sheet item in question. PwC’s report considers a range of items, including property, plant and equipment (PP&E), debt, working capital, goodwill and other intangibles, and pension liabilities.

Property, plant and equipment

The majority of respondents in PwC’s survey did not explicitly include the balance sheet amount for PP&E in their investment analysis.

However, PP&E data was considered useful in more asset-intensive businesses such as automotive (83 per cent) and retail (100 per cent).

In terms of measurement in the financial statements, most respondents (74 per cent) were satisfied with the status quo (historical cost less depreciation and impairment).

However, views were different when it came to disclosures – 52 per cent were seeking information about replacement cost and 37 per cent were looking for a sales price or similar measure of exit price.

Most of those favouring sales price were fixed income analysts – people generally more concerned about debt coverage and potential break-up values.

One respondent commented: “I would love to see a footnote on capital expenditures, breaking these things out into more detail in terms of maintenance and investment capital expenditure and where it has gone.”

Debt
According to PwC’s report, debt information is almost universally considered to be “very useful” (except in financial services) and particularly relevant for assessing credit risk. In almost all cases (86 per cent), the preferred measurement basis is the settlement amount rather than a current value.

One respondent said: “If I really want to know the market value of the debt, it’s on Bloomberg.”

“It’s interesting that the fixed income respondents and the equity specialists both by and large struggled with the value of marking-to-market quoted debt,” Thomas says.

“Fixed income analysts are really concerned with how much money will have to be paid out at what time in the future. They can get a lot of current value information from Bloomberg, so they are more concerned about inflows and outflows.”

Meanwhile, equity specialists are worried about the potential for marking to market to “muddy the waters” in terms of the income statement.

Working capital
In all sectors apart from financial services, information on working capital is at least seen as more useful than not.

It provides input to cash flow models (51 per cent) or gives evidence of business trends (42 per cent). All fixed income analysts participating in the survey used working capital data as an input to a cash flow model.

In terms of measurement, a small proportion (ten per cent) of respondents (across industry sectors) said that working capital should be measured on a current value basis. The remainder preferred a version of historical cost.

Goodwill and other intangibles
Most respondents to PwC’s survey said they did not consider goodwill balances in their company analyses – 70 per cent described goodwill as “not useful”.

Where some use is made of goodwill, it is to assess the success of past acquisitions. Analysts were ambivalent about its measurement.

Only 38 per cent expressed an opinion, and most of these respondents favoured measurement at historical cost less impairment.

Turning to other intangibles, many respondents viewed them in a similar way to goodwill – 74 per cent described information on intangible assets as “not useful”.

Participants were interested in the nature and amount of a company’s intangibles, but not in recognising such amounts in the balance sheet.

Concern was expressed about the reliability of data related to intangible assets. One survey respondent noted: “These things are incredibly hard to value. If you look at most businesses, much of the value is actually in the intangibles. But valuing them is impossible.”

Pension liabilities
PwC’s survey found considerable concern about accounting for defined benefit pension plans.

One respondent noted: “Smoothing mechanisms make pension accounting completely impenetrable for most people.”

Participants were unanimous in their desire to see the underlying economics of pension plans clearly reflected in the financials. There was little unanimity, however, about how this should best be done.

The potential impact of pension liabilities on company balance sheets was highlighted in Lane Clark & Peacock’s report, Accounting For Pensions 2006.

It estimated that under the relevant international accounting standard (IAS 19), the aggregate FTSE 100 deficit for UK defined benefit schemes was £36bn (53bn) in July 2006.

Given that most companies were opting to recognise defined benefit pension deficits in their balance sheets, volatility in equity and bond markets was having a direct impact on those balance sheets.

For example, the aggregate FTSE 100 deficit for UK defined benefit schemes hit a high of £54bn in January 2006, but fell to £29bn in April that year.

Sarah Perrin is a freelance business journalist