A company’s balance sheet is a financial record of its liabilities, assets and shareholder’s equity at a specific date. It helps evaluate a business’s capital structure and also calculates the rate of returns for its investors.
Moreover, you can pair a balance sheet with other financial statements to calculate financial ratios and conduct fundamental analysis.
What is the Balance Sheet?
The balance sheet is one of the three fundamental financial statements and is key to both financial modeling and accounting. The balance sheet displays the company’s total assets and how the assets are financed, either through either debt or equity. It can also be referred to as a statement of net worth or a statement of financial position. The balance sheet is based on the fundamental equation: Assets = Liabilities + Equity.
What are the features of a balance sheet?
- A balance sheet consists of all the liabilities and assets of a company. It shows their value and nature enabling you to know the position of the capital on a specific date. However, it does not show any revenues or expenses.
- Balance sheets follow the equation “Asset = Liability + Capital”, and both of its sides are always equal.
- It takes into account the credit as well as debit balances of a company’s current and personal accounts. The credit balance comes under the personal account and is called the liabilities of a business. In comparison, the debit balance comes under the real account and is known as the assets of a business.
- A company’s accountants generally prepare the balance sheet on the last day of an accounting year. This is so as it is the ultimate step of final accounts and needs an assessment of the company’s trading as well as profit and loss account for its preparation.
Components of a balance sheet
Liabilities
This section of the balance sheet shows the money that a company owes to others, like loan expenses, recurring expenses, other forms of debt, etc. Now, liabilities can be further subdivided into two categories:
- Current liabilities
Under current liabilities fall notes payable due within a year, current maturities of long-term, debt and accounts payable.
- Non-current liabilities
Non-current liabilities include deferred tax liabilities, bonds payable, long-term debt and notes payable in the long term.
Assets
In the assets section of the balance sheet, you will find items of value that can be converted into cash. These items will be listed in order of liquidity, that is, how easily they can be converted to cash.
Assets can be further subdivided into the following:
- Current assets
The assets that can be converted easily into cash within a year or less are called current assets. They have the following divisions:
| Assets | Particulars |
| Prepaid expenses | Items of value for which the company has already made a payment, like business insurance, office rent, etc. |
| Inventory | Raw materials, finished products, etc. |
| Accounts receivable | Money that a company’s clients owe for services rendered that is payable in the short term. |
| Marketable securities | Investments that a business can sell off within a year. |
| Cash and cash equivalents | Money saved in a firm’s checking and savings accounts, currency and checks. |
- Long-term assets
Those assets that cannot be converted into cash within a year are called long-term assets. You can further subdivide them into the following:
| Assets | Particulars |
| Fixed assets | Machinery, buildings, property, etc. |
| Intangible assets | Patents, copyrights, franchise agreements and more. |
| Long-term securities | Investments that a company cannot sell within a year. |
Shareholders’ equity
Shareholder’s equity is the amount of money stockholders have invested in a company. It includes the following:
- Retained earnings
It is the amount of a company’s gains that are reinvested into its business instead of returning to the shareholders in the form of dividends.
- Share capital
This is the amount of capital that a company receives for the purpose of business.
Importance of the Balance Sheet
- Liquidity – Comparing a company’s current assets to its current liabilities provides a picture of liquidity. Current assets should be greater than current liabilities, so the company can cover its short-term obligations. The Current Ratio and Quick Ratio are examples of liquidity financial metrics.
- Leverage – Looking at how a company is financed indicates how much leverage it has, which in turn indicates how much financial risk the company is taking. Comparing debt to equity and debt to total capital are common ways of assessing leverage on the balance sheet.
- Efficiency – By using the income statement in connection with the balance sheet, it’s possible to assess how efficiently a company uses its assets. For example, dividing revenue by the average total assets produces the Asset Turnover Ratio to indicate how efficiently the company turns assets into revenue. Additionally, the working capital cycle shows how well a company manages its cash in the short term.
- Rates of Return – The balance sheet can be used to evaluate how well a company generates returns. For example, dividing net income by shareholders’ equity produces Return on Equity (ROE), and dividing net income by total assets produces Return on Assets (ROA), and dividing net income by debt plus equity results in Return on Invested Capital (ROIC).
FAQs
What Is Included in the Balance Sheet?
The balance sheet includes information about a company’s assets and liabilities. Depending on the company, this might include short-term assets, such as cash and accounts receivable, or long-term assets such as property, plant, and equipment (PP&E). Likewise, its liabilities may include short-term obligations such as accounts payable and wages payable, or long-term liabilities such as bank loans and other debt obligations.
What Are the Uses of a Balance Sheet?
A balance sheet explains the financial position of a company at a specific point in time. As opposed to an income statement which reports financial information over a period of time, a balance sheet is used to determine the health of a company on a specific day.
A bank statement is often used by parties outside of a company to gauge the company’s health. Banks, lenders, and other institutions may calculate financial ratios off of the balance sheet balances to gauge how much risk a company carries, how liquid its assets are, and how likely the company will remain solvent.
A company can use its balance sheet to craft internal decisions, though the information presented is usually not as helpful as an income statement. A company may look at its balance sheet to measure risk, make sure it has enough cash on hand, and evaluate how it wants to raise more capital (through debt or equity).