Balance Sheet

The balance sheet is a sum total of a company’s income and expenses. In theory, the difference between the two determines whether or not the company is in a profit or loss. The underlying principle is very simple. If the assets are more than the liabilities, the company is in a profitable position, but if the opposite is reflected on the balance sheet, then there is a loss that has to be addressed and dealt with.

Importance of the Balance Sheet:

The balance sheet is an income-expenditure statement. It works like a statement for cash flow that, in time, becomes the cornerstone of the company's financial management strategies. The importance of this document affects investments made by shareholders of a company. The document is structured and designed to be simple, enlisting assets on one half of the page and liabilities on the other. All the entries are linear and date-wise, which makes the balance sheet easy to analyze and read.

The financial statement enables all those are influenced by the entries to understand the company’s position at any one given point in time. The balance sheet entries are based on the simple equation: assets = liabilities + equity of the shareholders. This formula makes it easier for finance analysts to understand a company’s position in the fiscal market.

Understanding the Balance Sheet:

The assets enlisted on the balance sheet are balanced by the financial obligations of the company, the equity investments and retained earnings. Assets refer to the resources used by the management to operate business or transact. On the other hand, liabilities and equity function as sources that support the assets at hand. The balance sheet enables the shareholders to know the value of their equity. The shareholder’s equity is the amount of money that the person or entity has initially invested into the company and the earnings thereof. The shareholder’s equity works like additional resource to fund business debt.

A balance sheet is an edited document that reveals the company’s financial position at any single point in time. The document lists both, the current and non-current assets. Current assets have a limited life span of maximum one year and can be converted very easily into cash. While on the other hand, non-current assets cannot be converted into cash easily and generally have a life-span of over a year. Current assets are cash, accounts receivable and the company’s inventory. Non-current assets comprise machinery, buildings, land, patents and copyright.

Asset depreciation is calculated and then deducted from the entries. The difference represents the economic cost of the asset and this value enables an investor to calculate his or her profitability in the investment. The liabilities listed in the balance sheet are the financial obligations of the company. They too are either current or long-term in nature. The company’s short and long-term borrowings and accounts payables greatly affect the investor’s interest in a company and its ability to handle business competition. The shareholders' equity that is displayed on the balance sheet represents the initial amount of money invested into the business. The earnings from the investment thus earned are transferred at the end of the fiscal year, if the company decides to reinvest the net earnings. The equity discloses the company's total net worth.

How To Read the Balance Sheet:

The balance sheet is typically divided into two sides. While the assets are reflected on the left of the page, the liabilities are displayed on the right side column, along with the shareholders’ equity. The entries are made date-wise and with brief details. In the asset side of the document, the accounts are classified from the most to the least liquid and on the liabilities side, the accounts are organized from short to long-term obligations. The sheet is organized to enable the finance analyst to check for business growth strategies and achieve the ‘balance’ by calculating the value of the assets and the combined value of the liabilities and equity.

Analysis of the Balance Sheet Ratios:

Once you understand the basics of the entries involved in a balance sheet, it is not at all difficult to analyze the information contained within. The financial ratio analysis involves the use of certain formulas to understand the company’s operations. The resultant calculation gives the analyst and subsequently the investor a better idea of the company’s financial position in the market and efficiency. The financial strength ratio provides information to the investor on whether or not the company can meet its obligations while heading towards a worst-case scenario like business bankruptcy. It also indicates whether the company’s obligations to the fiscal market can be leveraged. This in turn, shows the investors the financial stability of the company. Activity ratios enable the analyst and investor to gauge the versatility of the operating cycle, which include receivables and payables.

The balance sheet is an important financial tool for investors. The purpose of the document is to give investors an idea about the company’s financial planning and current position. Any company’s balance sheet is supposed to be made available at the fiscal year ending for detailed analysis and reinvestment.