How to Evaluate a Deficit Section in a Common-Size Balance Sheet
Original post by Bryan Keythman of Demand Media
A common-size balance sheet shows each dollar amount as a percentage of either total assets or total liabilities and stockholders’ equity, which are equal amounts. You may use these percentages to determine the relative size of different accounts. An accumulated deficit, a negative account in the stockholders’ equity section, shows that a company has generated more losses than profits since its beginning. A common-size balance sheet shows this account as a negative percentage. An accumulated deficit is typically a bad sign for investors, but you may evaluate this section to determine its effect on the company’s finances.
Identify the amount of the accumulated deficit percentage, listed in the stockholders’ equity section of a company’s common-size balance sheet. For example, assume a company’s common-size balance sheet shows an accumulated deficit of -3 percent.
Determine the absolute value of the negative percentage, which is the positive form of the percentage. A smaller absolute value percentage is better. In this example, the absolute value of -3 percent is 3 percent, which is a relatively small percentage. This means the company has an accumulated deficit equal to 3 percent of total liabilities and stockholders’ equity.
Identify the common-size percentage of the company’s total paid-in capital, listed in the stockholders’ equity section. This account represents the total amount of money stockholders have contributed to the company. In this example, assume the company’s common-size balance sheet shows total paid-in capital of 20 percent.
Compare total paid-in capital to the accumulated deficit. The greater the total paid-in capital percentage compared to the accumulated deficit’s absolute value percentage, the better. If accumulated deficit’s absolute value percentage is greater than the total paid-in capital’s percentage, the company will have a negative amount of stockholders’ equity, which means the accounting value of stockholders’ stake in the company is negative. In this example, total paid-in capital of 20 percent is higher than accumulated deficit’s absolute value of 3 percent, which means that the accumulated deficit has yet to reduce stockholders’ equity to zero.
Compare the accumulated deficit’s absolute value percentages over recent accounting periods to determine a positive or negative trend. An increasing absolute value percentage shows that the accumulated deficit is increasing as a percentage of assets, which suggests a worsening financial situation. A decreasing absolute value percentage means accumulated deficit is getting smaller as a percentage of assets, which suggests the company’s financial situation may be improving. Continuing with the example, if the accumulated deficit’s absolute value percentage has decreased from 10 percent to 5 percent to 3 percent in recent years, the company may be improving its situation.
Tips & Warnings
- Read a company’s annual report, including its management’s discussion, to determine its reason for the accumulated deficit and its outlook for the future.
- College Accounting, 11th Edition; John Ellis Price et al.
- AccountingTools: What Are Negative Retained Earnings?
- Accounting for Management: Vertical Analysis and Common-Size Statements
About the Author
Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.