A balance sheet represents a company’s net worth at the end of a certain time period. Many companies will deliver these statements at the end of their natural business year, commonly at the point in their fiscal year where business activities are at their lowest point, or quarterly, and in some cases such as banking, mutual funds, and securities brokers, it is prepared at the end of the business day. The balance sheet is created to state the company’s net worth or to understand the financial condition at that time. The net worth of the company doesn’t necessarily mean the actual “book value” of the company – there’s many factors that determine what a company is truly worth. The balance sheet differs from the other financial statements in that it shows balances at one point in time versus income statements and cash flows which represents figures over periods of time, however, these statements are most commonly listed in sync with one another.
The statement is always broken down into three sections; assets, liabilities and equity. On the actual balance sheet, assets are equal to liabilities and equity, where assets are the company’s resources, liabilities are their financial obligations and equity is the ownership of their assets that have been completely paid for and can be readily turned into cash.
The company’s assets will be listed as current, or liquid, and non-current, or non-liquid assets, and five or more assets are typically reported. Current assets will include cash and cash equivalents, accounts receivables (sales made on credit), inventory of unsold products (at cost). All of the company’s current assets are equivalent to cash, in that, if the company needs cash quickly, usually within one year, they will be able to liquidate these assets. Same logic for non-current assets, except the company cannot liquidate these assets as easily. They include long-term operating assets or the company’s plant, property and equipment (PPE), at cost, less cumulative amount charged off to depreciation expense, amortization, and goodwill.
Now, the company’s liabilities and owner’s equity are listed together. Another way to look at our financial equation is to remember that the equity in the business is what is owned less what is owed (working capital). Liabilities will include accounts payable (owed for credit used), current borrowing (loans), or other current liabilities, usually these are liabilities that cannot be rolled into accounts payable or current borrowing. Non-current liabilities include paid-in capital and retained earnings. Paid-in capital includes money ‘paid-in’ by investors during common or preferred stock issuances where retained earnings is the amount of earnings not paid out as dividends, but retained by the company to be reinvested in its core business or to pay debt.
By understanding the balance sheet, one can then use ratios to have a better feel for how the company is doing financially. Some of the ratios include working capital, current ratio, quick ratio, accounts receivable turnover, days’ sales in accounts receivables, inventory turnover, days’ sales in inventory, and debt to equity ratio. These ratios help investors and owners to quickly understand where the business stands, for example, working capital is an indicator of whether the company will be able to meet its current obligations. The greater the amount of working capital the more likely it will be able to make its payments on time. The debt equity ratio is the proportion of assets supplied by the creditors versus the amount supplied the owner or stockholders. It can be a good indicator of the amount of debt owed and the credit health of the company.
Overall, the balance sheet works well to understand a company’s financial condition at one point in time. It’s like a health check to make sure the company is on the right track!
