of the combined companies on one balance sheet. This is called a consoli-
dated balance sheet. All the assets of the subsidiary are brought onto the
parent company’s balance sheet, and similarly all the liabilities are com-
bined with the parent company’s liabilities. The book value of the sub-
sidiary company’s minority stock (i.e., those shares of stock the parent
company does not own) will be placed on the balance sheet midway be-
tween the liability and capital sections, since this account, usually entitled
“interest of minority shareholders in consolidated subsidiaries,” is some-
what of a hybrid. Since the actual assets and liabilities of the subsidiary
company are brought onto the statement, the account representing the par-
ent company’s investment in the subsidiary is eliminated from the consoli-
dated balance sheet. If at the time the parent company acquired the
subsidiary it paid less than the net asset value (net book value) of the stock,
the difference is labeled “surplus arising from consolidation” and consid-
ered one of the capital surplus items. Any growth in the subsidiary’s book
value since acquisition, such as the parent company’s share of the sub-
sidiary’s retained earnings since the purchase, is considered a part of the
consolidated earned surplus.
We show the AOL Personal Finance (Thomson) balance sheet for
Johnson & Johnson in Table 2.1.
On December 31, 2003, the company had an investment of $22.995
billion in current assets, and current liabilities of $13.448 billion. Johnson
& Johnson has invested funds in its current assets, relative to its current li-
abilities. The excess of the firm’s current assets relative to its current liabil-
ities is often referred to as the firm’s net working capital. One could ask if
the investment in its net working capital is large, and if so, relative to what
level. Let us introduce several ratios that are useful to assessing the firm’s
balance sheet.
We can calculate the ratio of the firm’s current assets relative to its total
assets, and compare that ratio to the median ratio of all firms, or firms
within the company’s sector or industry. The greater the ratio of current as-
sets to total assets (CATA), the greater is the firm’s liquidity, and the greater
is the firm’s ability to pay its short-term creditors. A second ratio is the ratio
of current liabilities to total assets (CLTA). A higher CLTA indicates lower
liquidity and potentially higher risk. A third ratio is the ratio of current lia-
bilities plus long-term debt to total assets, denoted total debt to total assets
(TDTA). Current liabilities plus long-term debt represents the vast majority
of total liabilities of the firm; the TDTA ratio ignores provisions for risks and
charges, deferred income, and deferred taxes and other liabilities. The TDTA
ratio allows the investor to assess much of the leverage factor, or how much
of its fixed obligations funds the firm borrows from the capital markets. As
of December 31, 2003, Johnson & Johnson had a CATA of 0.476, whereas
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