A Balance Sheet: What Is It?

A balance sheet is a type of financial statement that shows a business’s assets, liabilities, and shareholder equity at a certain point in time. The foundation for calculating investor rates of return and assessing a company’s capital structure is its balance sheet.

Simply put, a balance sheet is a financial statement that lists a company’s assets, liabilities, and shareholder investment. Financial ratio calculations and fundamental analysis can be performed on balance sheets with other significant financial statements.

How Balance Sheets Operate

The balance sheet provides an overview of a corporation’s financial situation at any given time. It cannot convey the impression that trends are developing over a longer time frame. The balance sheet ought to be compared to those from earlier times because of this.

Investors can assess the firm’s financial health using the debt-to-equity ratio, the acid-test ratio, and many other ratios available from a balance sheet. Any comments or addenda in an earnings report that may refer to the balance sheet can offer helpful context for evaluating a company’s finances, as do the income statement and statement of cash flows.

The balance sheet aligns with the accounting equation, which states that assets plus liabilities plus shareholder equity balance out on one side.

Resources
=
Accounts Payable
+
Equity of Shareholders
Liabilities + Equity from Shareholders = Assets

This formula makes sense. This is because an organization must either borrow money (assuming liabilities) or take it from investors (issue shareholder equity) to pay for all it has (assets).

A company’s assets (mainly the cash account) will rise by $4,000 if it takes out a $4,000 loan from a bank for five years. The long-term debt account, which is its liability, will rise by $4,000, bringing the two sides of the equation into balance. The company’s assets and shareholder equity will rise by $8,000 if it raises $8,000 from investors. Any surplus income the business makes above its costs will be deposited into the shareholder equity account. These revenues will show up as cash, investments, inventories, or other assets to balance the asset side.

Since every sector has a different financing strategy, balance sheets from companies in the same industry should also be compared.

Particular Points to Remember

As previously mentioned, a company’s balance sheet contains details on its assets, liabilities, and shareholder equity. Always keep the assets, liabilities, and shareholder equity equal. The term comes from the idea that the balance sheet should always balance. If they are out of balance, there might be several issues, such as inaccurate or missing data, mistakes in inventory or exchange rates, or improper computations.

Each category breaks down the intricacies of a company’s finances into several smaller accounts. These accounts change significantly depending on the industry, and based on the type of firm, the same terminology may have distinct meanings. However, investors are likely to encounter a few similar components.

What Can You Learn From a Company’s Balance Sheet?

What Makes Up a Balance Sheet

Resources
In this sector, the accounts are arranged in ascending order of liquidity. This is how simple it is to turn them into money. They are separated into two categories: non-current or long-term assets, which cannot be converted into cash, and current assets, which can in a year or less.

The typical hierarchy of accounts within current assets is as follows:

• The most liquid assets are cash and cash equivalents, which can comprise physical money and short-term certificates of deposit and Treasury bills.
  Marketable securities include debt and equity instruments with a well-functioning market.
  Money that clients owe the business is referred to as accounts receivable (AR). This should contain a provision for shaky accounts because some clients might not fully pay their debts.
  Any item valued at less than its cost or market worth and offered for sale is referred to as inventory.

Prepaid costs, such as rent, advertising contracts, and insurance, indicate the value already paid.
Among the long-term assets are the following:

• Securities that cannot or will not be liquidated within the following year are considered long-term investments.
  Land, buildings, machinery, equipment, and other long-lasting, typically capital-intensive assets are examples of fixed assets.
  Non-physical but still valuable assets like goodwill and intellectual property are considered intangible assets. Usually, these assets aren’t included on the balance sheet unless bought instead of being internally created. As such, their significance might be equally inflated or drastically minimized (for example, by omitting a widely recognized brand).

Accounts Payable
Any money a business owes to other parties, including rent, utilities, wages, interest on bonds issued to creditors, and bills it must pay to suppliers, is an obligation. Current obligations are arranged in chronological order of due date and are due within a year. In contrast, long-term obligations can be paid off anytime after a year.

Accounts for current obligations might consist of the following:

• The part of a long-term debt due in the upcoming year is known as the current portion of the debt. One year is a current obligation, and nine years is a long-term liability, for instance, if a corporation has ten years remaining on a loan to pay for its warehouse.
• Interest payable is the total interest owed, sometimes a component of an overdue debt like unpaid property taxes.
  Salary, earnings, and employee perks are frequently referred to as wages payable for the most recent pay period.
• Customer prepayments are sums of money a customer receives before delivering a a good or service. The business must either (a) deliver the item or service or (b) give the client their money back.
• Dividends that have been approved for payment but have not yet been distributed are referred to as dividends payable.
• Prepayments and earned and unearned premiums are comparable in that a business receives payment in advance, hasn’t fulfilled the end of the contract yet, and is required to reimburse unearned funds if it doesn’t fulfill its end.
• Frequently, the most prevalent current obligation is accounts payable. Debt obligations on invoices handled as part of a business’s operations, which are frequently due within 30 days after receipt, are referred to as accounts payable.

Long-term obligations may consist of:

• Any interest and principal owed on bonds issued are considered long-term debt.
  The amount of money a business must contribute to its employees’ retirement accounts is known as its pension fund liabilities.
  The amount of accumulated taxes that will not be paid for another year is known as the deferred tax liability. In addition to time, this number balances discrepancies in financial reporting standards and tax assessment methods, such as depreciation computations.
  Certain obligations are not included on the balance sheet and are thus referred to as off-balance sheet liabilities.

Equity for Shareholders

The amount of money owed to a company’s owners or shareholders is known as shareholder equity. Since it is equal to a company’s total assets less its liabilities, or the debt it owes to non-shareholders, it is also known as net assets.

The net earnings that a firm either utilizes to pay off debt or reinvests in the company are known as retained earnings. Dividends on the remaining amount are given to the shareholders.

A company’s repurchased shares are known as treasury stock. It can be kept to stave off a hostile takeover or sold later to raise money.

Some firms issue preferred stock, apart from common stock, which will be included in this section. Similar to common stock in certain situations, preferred stock is given an arbitrary par value unrelated to the share market value. To calculate the par value of the ordinary and preferred stock accounts, multiply it by the total number of shares issued.

The amount that shareholders have invested above the standard or preferred stock accounts—based on par value rather than market price—is known as additional paid-in capital, also known as capital surplus. No apparent correlation exists between a company’s market capitalization and shareholder equity. A stock’s current price determines the latter, whereas paid-in capital is the total amount of equity acquired at any price.

Par value is typically only a very tiny sum, like $0.01.

The significance of balance sheets

The benefits of reading, evaluating, and comprehending a company’s balance sheet are numerous, regardless of the size of the business or the sector in which it operates.

To start, balance sheets help assess risk. This financial statement enumerates all the assets and debts the business holds. A business will be able to determine quickly if it has taken on excessive debt, if its assets are not sufficiently liquid, or if it has enough cash on hand to cover its immediate needs.

Capital is also secured through the use of balance sheets. A corporation often has to give a lender a balance sheet to get a business loan. When seeking private equity capital, a business typically has to give a balance sheet to private investors. The objective of the external party in both situations is to evaluate the company’s creditworthiness, financial stability, and ability to pay back short-term obligations.

Financial ratios are a tool that managers may use to assess a company’s liquidity, profitability, solvency, and cadence (turnover). Specific financial ratios require data to be collected from the balance sheet. Managers can better identify methods to strengthen a company’s financial standing when they examine data over an extended period or in comparison to rival businesses.

Finally, balance sheets have the potential to attract and retain talent. Workers often want to know that their jobs are safe and that their employer is doing well. Employees can check how much cash the company has on hand, whether it is managing debt wisely, and whether its financial health aligns with what they expect from their employer by reviewing the balance sheet of publicly traded companies that must disclose it.

The Balance Sheet’s Limitations

The balance sheet has several disadvantages, even though it is a handy tool for analysts and investors. Since the balance sheet is static, many financial ratios combine information from the more dynamic income statement and statement of cash flows, as well as the balance sheet, to provide a more complete view of a company’s business operations. Because of this, a balance by itself could not provide a complete picture of a company’s financial situation.

A balance sheet’s restricted timeliness makes it unusable. A company’s financial situation is only depicted daily in the financial statement. Assessing a company’s performance only based on a single balance sheet may be challenging. Consider a scenario where a business reports having $1,000,000 in cash at the end of each month. If context, a reference point, knowledge of a company’s prior cash balance, and awareness of the operational requirements of the industry are not present, knowing a company’s cash on hand does not add much value.

The values recorded on a balance sheet will also vary depending on the accounting system used and the methods used to handle inventory and depreciation. Managers can, therefore, manipulate the figures to appear more favorable. Examine the footnotes of the balance sheet to find out which systems are being utilized for their accounting and to keep an eye out for any suspicious activity.

Finally, a balance sheet is susceptible to several expert judgment calls that might significantly affect the report. For instance, it’s necessary to regularly evaluate accounts receivable for impairment and adjust for accounts that could not be recoverable. Businesses must estimate their receivables and provide their best estimate on the balance sheet, as they cannot know which ones they will likely receive.

A Balance Sheet Example

In this instance, Apple’s $323.8 billion total assets are arranged near the report’s top. The assets in this part are divided into two groups: current assets and non-current assets. These categories are further subdivided into more specialized accounts. A cursory examination of Apple’s assets reveals a rise in non-current assets but a loss in cash on hand.

Apple’s equity and liabilities are also included in this balance sheet; each is included in a separate section in the latter part of the document. Like the assets part, the liabilities section is divided into current and non-current obligations, with amounts shown per account for each. Retained profits, cumulative other comprehensive income, and the value of common stock are all included under the section on total shareholder equity. Apple’s total assets are equal to the sum of its total liabilities and total equity, which have both risen and decreased.

What Makes a Balance Sheet Crucial?

Executives, investors, analysts, and regulators utilize the balance sheet as a crucial tool to comprehend the present financial health of a company. The income and cash flow statements are the two other forms of financial statements that are typically used in conjunction with it.

A quick overview of the company’s assets and liabilities is provided by the balance sheets. The balance sheet may assist users in determining if a firm is overly leveraged compared to its rivals, whether it has a positive net value, and whether it has adequate cash and short-term assets to pay its commitments.

What does the balance sheet contain?

The assets and liabilities of a corporation are detailed on the balance sheet. Depending on the business, this might comprise long-term assets like property, plant, and equipment (PP&E) or short-term assets like cash and accounts receivable. Similarly, its liabilities can consist of long-term debt commitments like bank loans and other obligations or short-term ones like accounts payable and salaries payable.

What is the balance sheet? Who does it?

Depending on the firm, several people may prepare the balance sheet. A company bookkeeper or the owner may compile the balance statement for small, privately owned companies. They may be created internally for mid-sized private companies and reviewed by an outside accountant.

In contrast, public firms must maintain their records to a far higher standard and undergo external audits by public accountants. These businesses must compile their balance sheets and other financial statements in compliance with Generally Accepted Accounting Principles (GAAP) and regularly submit them to the Securities and Exchange Commission (SEC).

What functions does a balance sheet serve?

A balance sheet provides information on a company’s financial status at a particular time. A balance sheet is used to assess a company’s financial situation on a given day, as opposed to an income statement, which presents financial data over an extended period.

External parties frequently use a bank statement to assess the health of a firm. Financial ratios are derived from balance sheet balances. Banks, lenders, and other organizations may use them to assess a company’s level of risk, asset liquidity, and likelihood of survival.

Although the data on a balance sheet is typically not as valuable as that on an income statement, a corporation can utilize it to make internal choices. A business may use its balance sheet to assess risk, confirm its adequate cash, and choose whether to borrow additional funds (either through debt or stock).

The Balance Sheet Formula: What Is It?

A balance sheet is produced by dividing an organization’s equity and liabilities by its assets. Total assets equals total liabilities plus total equity is the calculation.

The total of all assets, including long-term, short-term, and other assets, is the total assets. The total of all long-term, short-term, and other obligations is used to compute total liabilities. The total of net income, retained profits, owner contributions, and issued shares of stock is the total equity.

Conclusion

• A balance sheet is a financial statement that lists an organization’s assets, liabilities, and shareholder equity.
• The balance sheet is one of the three primary financial statements used to assess a company’s performance.
• It offers a glance into the assets and liabilities of a business as of the publishing date.
• The assets on the balance sheet equal the sum of the liabilities and shareholder equity.
• Fundamental analysts use balance sheets to compute financial ratios.