A balance sheet provides a snapshot of what a company owns and owes at a specific point in time. It consists of three categories: assets, liabilities and owner’s equity. The equation, Assets = Liabilities + Shareholders’ Equity, must always be satisfied to have a balanced sheet. The most important information can be found within the current assets and current liabilities sections of the balance sheet. The rest of the information can be derived from additional analysis of the underlying data, such as through financial ratios that assess a company’s efficiency and growth potential.
Assets: The things a business owns that have inherent, quantifiable value. They include cash, accounts receivable, inventory, property, plant and equipment, and intangibles. These are tallied as positive numbers on the balance sheet and usually broken down further into current and noncurrent assets.
Current assets must be greater than current liabilities in order for a business to have sufficient working capital to pay its bills. If it isn’t, it may need to raise funds by selling current assets or borrowing money. Alternatively, it may need to reduce expenses, increase sales or get investors to add capital into the business.
A company may also have a lot of long-term assets that aren’t going to be sold, such as land or buildings. These are called fixed assets and may depreciate over time. A company’s total fixed assets must be less than its total current assets in order for the company to have a positive net worth.
Liabilities: The amounts a company owes to others at the reporting date. These are called claims on the company’s assets. They can be in the form of accounts payable, notes payable due within a year, debtors’ receivable, accrued taxes and deferred income. Long-term liabilities would be items such as pension payments, debt maturities and interest and principal on corporate bonds. Equity: The remainder of the balance sheet is reserved for Shareholders’ Equity, which can be broken down into common stock and retained earnings. Common stock is the money invested by shareholders in a company and retained earnings are the profits that aren’t distributed to shareholders as dividends.
When viewed in conjunction with the income statement, a balance sheet gives you a complete picture of how well a company is operating. A company’s efficiency can be measured by its asset turnover ratio, which is a measure of how often assets are turned into revenue, and its profitability can be assessed by its gross profit margin and operating margin. By analyzing the relationship between the balance sheet and other financial statements, you can see how a company is performing and determine whether any changes are needed. By practicing sound accounting practices, you can help ensure that your balance sheet is accurate and up-to-date at all times. This will help you avoid costly mistakes and identify new opportunities to manage your business’s finances. By using a tool such as your business checking account to simplify the process, you can also make creating a balance sheet easier. Bilanz
