What Is a Balance Sheet, and How Do You Read One?

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Balance sheet of a company is a financial document released to show the number of assets, overall shareholder equity, and liabilities. A company’s current financial information is mentioned in a balance sheet. If you want to have a comparison of numbers on an annual or monthly basis, you will need to access other historical documents. These documents hold much importance as they talk about a company’s financial health. They are also considered valuable resources by investors.  

Information that a Balance sheet of a company provides: 

A balance sheet of a company gives you information about three valuable things about that company that includes: 

  • Assets– How many assets does a company own?  
  • Liabilities– How many liabilities does a company have. 
  • Shareholder equity– This is what is left when you subtract the number of liabilities from the number of assets. 
  • A balance sheet is used to show the financial status at one point in time. 

How to analyze assets on a balance sheet? 

Any value that a company possesses is called an asset. Assets include investments, cash, and other tangible objects. Companies often divide their assets into 2 groups, namely current assets and long-term assets.  

Current Assets 

Assets that a company can convert into money within a year are called current assets. Current assets include cash, investments such as bonds or stocks, physical inventory, and prepaid expenses. The responsibility of a balance sheet is to break down the value of each current asset.  

Long term assets

. Long-term assets include furniture, vehicles, property, buildings, equipment, and machinery. The terms “fixed-assets” or “non-current assets” are often used by companies to indicate these long-term assets.  

How to analyze liabilities on a balance sheet? 

The amount of money that a company uses is termed a liability. Liabilities include utilities, company salaries, supplies, rent, loans, or deferred taxes. There are 2 types of liabilities that a company has, which are: 

  • Current liabilities– These are the liabilities that a company owes within the next year. These include accounts payable that a company owes to its suppliers, notes payable, and current debt.   
  • Long-term liabilities– These include bonds payable, which are bonds that a company-issued, and other long-term debts or liabilities. 

How to analyze Shareholder Equity on a balance sheet? 

  The money that goes to the company’s shareholders or owners is termed as Shareholders’ Equity. This is calculated by subtracting the number of assets by the number of liabilities. Shareholders’ Equity is simply the company’s net income. Shareholders’ Equity is an essential number for all investors as it indicates a company’s worth. Greater Equity, higher is the amount of money for shareholders.  

Sometimes, there are certain situations in which a company experiences negative Equity, this means the value of its assets is not enough to cover the number of a company’s liabilities. This situation is most common in startups and new companies. A company that has negative Equity is a risk for investment when compared to companies with positive Equity.  

Some common terms used for understanding the Shareholders’ equity concept: 

  • Retained earnings– The amount of money that a company keeps is its retained earnings.  
  • Share Capital- The value of money the investors have invested in the company.  
  • Stocks – stocks are divided into common stockholders and preferred stockholders. If a company were to liquidate all its assets and earnings, the preference is first given to the preferred stockholders and then to the common stockholders.  

Benefits of maintaining a balance sheet: 

The balance sheet of a company indicates its worth. Investors use these numbers from the balance sheet to find helpful financial equations that help in analyzing the company’s value. Here are a few: 

1. Working capital= current assets – current liabilities 

The working capital is the capital a company uses in its day-to-day trading operations. 

2. Debt-to-equity ratio= total liabilities ÷ shareholders’ Equity 

This ratio tells you how much of a company’s finance is from investors in comparison to creditors. A risky investment is when the ratio is high (that is if there is more financing from debt.) Unlike in the case of Equity, the company needs to pay back the amount it owes.  

3. Quick ratio = ( cash equivalents + securities + accounts receivable) ÷ current liabilities 

The quick ratio is a measure of a company’s ability to pay back its short-term liabilities.  

A balance sheet of a company, details the company’s assets, liabilities, and the value of its stock. It is a beneficial financial document for investors, which can be used in conjunction with other documents such as a cash flow statement or an income statement. Financial advisors have proficiency in analyzing and evaluating a balance sheet. Tofler is the largest company in India that helps you in analyzing financial statements. This company enables you to review the funding sources, operational and financial leverage, operational efficiency of your business from a financial angle, profitability, and many other areas.

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