Definition:
A balance sheet is an important financial statement that a company makes. This report provides its financial situation: the presence of assets liabilities and equity.
For clarity, it is necessary to imagine the scales. Then, the balance sheet can be expressed as a financial equation that is in perfect equilibrium at any time. Balance sheet is one of the most common financial statements. It shows the amount of all assets a company owns and equates it to the amount of their liabilities (long-term debts, bills, loans) as well as the shareholders’ equity.
This form of reporting is actively used by analysts and investors to examine information about the company, its funding sources, growth support and ordinary operations. The sum of assets in balance sheet always equals the sum of liabilities and equity of the company.
An asset is something a company possesses and that has worth, either in the form of cash or value, needed to operate the business.
A liability, which can be long-term or short-term, is the debt the company owes to third parties.
Where to read a Balance Sheet?
The regulator requires public companies to fill out financial statements and updates once a quarter and keep them publicly available. Balance sheets, as mentioned earlier, are one type of these financial statements. You can find them in quarter reports that are published on the company’s website.
Private companies are not required to reveal their financial position and usually do so only to a limited circle of people (the board of directors, the largest shareholders).
Balance sheets usually list assets and liabilities in order of how easily they can be converted into cash, which means how ‘liquid’ they are on financial jargon.
How to analyze balance sheets?
For example, you can plot the debt-to-equity ratio, this helps figure out the potential value of the stock if the company closes, sells its assets, or pays its debts.
Using the ratio method:
– Activity ratios. These focus on current accounts and show how efficiently a company generates income using its own cash and resources: inventory, accounts payable and accounts receivable.
– Financial Strength Ratios. These ratios show the stability of a company in meeting its obligations (like payments to creditors). They can also be used to see how the company finances its operations; how easily it can meet its short-term obligations with available working (short-term) cash.
Why are balance sheets useful?
Balance sheets can provide key information about how a company covers its expenses and how efficiently it operates. They can help investors understand a company’s situation and state of affairs relatively quickly, and they are also useful for creditors.
Disadvantages of balance sheets
– Historical limitations. Balance sheets provide information and reflect financial events that have already passed, But, of course, this type of reporting can help predict the future trajectory of the company.
– A limited list of assets. The balance sheet accounts consider only those assets that are acquired by the company as a result of transactions. Goodwill in the balance sheet is intangible assets (technology, patents, brand). However, it is quite difficult to quantify them.
– Assets valuation rules. Long-term assets, such as land or real estate, in the balance sheet are equal to the transaction price less accumulated depreciation. On the balance sheet, this is reported as an expense during a financial period, such as a year, over the period of use of that asset. For example, depreciation expense on a $10,000 smoothie machine with a 10-year best before date might look like a company expense of $1,000 each year for 10 years, even though the market value of the property or land has increased over time. As a result, the market value of the company’s land and buildings may be very different from what is reflected in the balance sheet equation. This is taken into account when assets are sold, and they are referred to as ‘gain or loss on sale of assets.