A balance sheet is a financial document used to track and analyze the financial health of a business. It lists all of the assets, liabilities, and shareholders’ equity associated with the enterprise, and provides insight into its performance and overall financial health. The balance sheet provides stakeholders with a comprehensive overview of a company’s financial status and is a standard component of most financial statements.
Overview
A balance sheet is a document that outlines the assets, liabilities, and equity of a company. It allows stakeholders to assess the financial health of an enterprise at a given moment in time and evaluate its performance over a certain period. This document is one of the key components of a company’s financial statements.
The balance sheet is composed of two groups of accounts: Assets and Liabilities + Equity. In its simplest form, the sheet consists of three columns representing these 3 sections, and any entries on the left side must equal the entries on the right side. To ensure the sheet is balanced, the following equation is used:
Assets = Liabilities + Shareholders’ Equity
This equation is also known as the ‘Accounting equation’ or ‘fundamental accounting equation’.
When assets exceed liabilities + equity, the company will have a positive net worth. When liabilities exceed assets, the company will have a negative net worth.
Information Presented on a Balance Sheet
A standard balance sheet consists of the following information:
Assets
* Cash and cash equivalents
* Marketable securities
* Accounts receivable
* Inventory
* Property, plant, and equipment
* Intangible assets
Liabilities
* Accounts payable
* Taxes payable
* Short-term and long-term debt
* Accruals
* Deferred revenue
Shareholders’ Equity
* Common and preferred stock
* Additional paid-in capital
* Retained earnings
Analysis of a Balance Sheet
Interpreting a balance sheet requires careful analysis of its information in order to gain valuable insights into the financial performance of a company. This analysis also helps financial managers make important decisions, such as when to acquire new assets or when to add more liabilities.
The following analysis techniques can be used to assess the financial health of a company from its balance sheet:
* Comparing change in liabilities: observe any changes in the amount of debt or accounts payable over time, in order to determine the company’s cost of capital.
* Analyzing asset ratios: calculate the ratio of current to non-current assets, in order to ensure the company can pay off its short-term debts.
* Examining asset liquidity: assess the ability of a company to generate cash from its assets.
* Calculating debt to equity ratio: compare the amount of debt to shareholders’ equity in order to measure financial leverage.
Real-World Example
For instance, XYZ, Inc. is a publicly-traded company with $20 million in assets, $7 million in liabilities, and $13 million in shareholders’ equity. This means the equation for XYZ, Inc. is balanced (assets = liabilities + shareholders’ equity). Furthermore, its debt to equity ratio is $7 million to $13 million, or 7:13, indicating that the company is managing its debt levels effectively.
Conclusion
A balance sheet is a financial document used to track and analyze the financial health of a business. It lists the company’s assets, liabilities, and shareholders’ equity, and helps stakeholders and financial managers assess the company’s financial health and compare its performance over time. By carefully analyzing a balance sheet, financial managers can make more informed decisions that are beneficial to the business.