The balance sheet of a company is one of its three financial reporting documents. Used to give a snapshot of the company’s past financial statement at any given point, it is cumulative in nature.
Simple balance sheets contain three elements: Assets, Liabilities, and Equity. Following positions may be shown in a balance sheet:
- Current Assets (e.g.: account receivables, cash positions)
- Non-current Assets (e.g.: property, intangible assets, other fixed assets)
- Current Liabilities (positions, which will be liquidated within 12 months) (e.g. account payables, wages, short-term obligations)
- Long-term Liabilities (positions, which will be liquidated after next 12 months): (e.g. pensions, long-term bonds or leases, product warranties)
III. Ownership equity
- Capital paid in and retained earnings
Typically noted with assets on one side of the spreadsheet, and liabilities and ownership equity on the other, the idea is that the numbers will balance each other. Hence the following rule should apply:
_ ASSETS = LIABILITIES + OWNERSHIP EQUITY
By categorizing the data on the budget sheet into these three elements, it is easy to find where breakdown may have occurred and identify areas of the company that need improvement. By analysing a balance sheet and calculating several metrics the health of a company can be assessed more precisely. Here are some of the ratios:
- Liquidity ratios provide informations, on the firm’s ability to pay its short-term liabilities: e.g. Current ratio, Quick ratio, Cash ratio
- Solvency ratios (debt ratios) present information on a firm’s financial leverage and ability to meet its long-term obligations: Debt-to-Equity, Dept-to-Capital, Debt-to-Assets, Financial leverage
There are accounting guidelines (national and/or international) that give specific regulations for balance sheets, and ensure that all companies are held to a standard. This ensures that company valuations are consistent across various industries and companies.
While a balance sheet can be prepared at any time (e.g. monthly, quarterly, yearly), most businesses find it easier to manage their balance sheet on a monthly basis – allowing for monthly reports that show profit/loss – instead of waiting for an annual report to see how the company is faring. Specific information can be accumulated by the company’s accountant, and give potential investors a realistic look at what is actually happening in the company.
The larger and more complex the company, the more detailed and complex the balance sheet will be. Businesses may have balance sheets for different departments within the company, and the totals may be reflected on a general balance sheet for the overall company. Using a balance sheet can be a way to take the temperature of a company – it gives you instant information about how well a company is performing and can help manage decisions about the future participation of the company.
For more information please read Basic accounting principles.