A balance sheet is a financial statement that shows the relationship between assets, liabilities, and shareholders’ equity of a company at a specific point in time.
Measuring a company’s net worth, a balance sheet shows what a company owns and how these assets are financed, either through debt or equity.
Balance sheets are useful tools for individual and institutional investors, as well as key stakeholders within an organization, as they show the general financial status of the company.
It is also possible to grasp the information found in a balance sheet to calculate important company metrics, such as profitability, liquidity, and debt-to-equity ratio.
However, it is crucial to remember that balance sheets communicate information as of a specific date. Naturally, a balance sheet is always based upon past data.
While stakeholders and investors may use a balance sheet to predict future performance, past performance does not guarantee future results.
In order to see the direction of a company, you will need to look at balance sheets over a time period of months or years.
Both parts should be equal to each other or balance each other out. This means that the assets of a company should equal its liabilities plus any shareholders’ equity that has been issued. Hence, a balance sheet should always balance.
For instance, if a company takes out a ten-year, $8,000 loan from a bank, the assets of the company will increase by $8,000. Its liabilities will also increase by $8,000, balancing the two sides of the accounting equation.
If the company takes $10,000 from its investors, its assets and stockholders’ equity will also increase by that amount.
The revenues of the company in excess of its expenses will go into the shareholder equity account.
These revenues will be balanced on the asset side of the equation, appearing as inventory, cash, investments, or other assets.
A balance sheet has three primary components: assets, liabilities, and shareholders’ equity.
Assets are anything the company owns that holds some quantifiable value, which means that they could be liquidated and turned into cash.
These can include cash, investments, and tangible objects.
Companies divide their assets into two categories: current assets and noncurrent (long-term) assets.
For example, this balance sheet tells you:
It is crucial to note that how a balance sheet is formatted differs depending on where the company or organization is based.
The balance sheet is prepared using the following steps:
The balance sheet previews the total assets, liabilities, and shareholders’ equity of a company on a specific date, referred to as the reporting date.
Often, the reporting date will be the final day of the reporting period. Companies that report annually, like Tesla, often use December 31st as their reporting date, though they can choose any date.
There are also companies, like publicly traded ones, that will report quarterly. For this case, the reporting date will usually fall on the last day of the quarter:
However, it is common for a balance sheet to take a few days or weeks to prepare after the reporting period has ended.
You will need to tally up all your assets of the company on the balance sheet as of that date. This will include both current and noncurrent assets.
Assets are typically listed as individual line items and then as total assets in a balance sheet.
This will make it easier for analysts to comprehend exactly what your assets are and where they came from. Tallying the assets together will be required for final analysis.
Like assets, you need to identify your liabilities which will include both current and long-term liabilities.
Again, these should be organized into both line items and total liabilities. They should also be both subtotaled and then totaled together.
After you have assets and liabilities, calculating shareholders’ equity is done by taking the total value of assets and subtracting the total value of liabilities.
Shareholders’ equity will be straightforward for companies or organizations that a single owner privately holds.
The calculation may be complicated for publicly held companies depending on the various types of stock issued.
Line items in this section include common stocks, preferred stocks, share capital, treasury stocks, and retained earnings.
Adding total liabilities to shareholders’ equity should give you the same sum as your assets. If not, then there may be an error in your calculations.
Causes of a balance sheet not truly balancing may be:
Financial ratio analysis is the main technique to analyze the information contained within a balance sheet.
It uses formulas to obtain insights into a company and its operations.
Using financial ratios in analyzing a balance sheet, like the debt-to-equity ratio, can produce a good sense of the financial condition of the company and its operational efficiency.
It is crucial to remember that some ratios will require information from more than one financial statement, such as from the income statement and the balance sheet.
There are two types of ratios that use data from a balance sheet. These are:
Financial strength ratios can provide investors with ideas of how financially stable the company is and whether it finances itself.
It also yields information on how well a company can meet its obligations and how these obligations are leveraged.
Financial strength ratios can include the working capital and debt-to-equity ratios.
Activity ratios mainly focus on current accounts to reveal how well the company manages its operating cycle.
These operating cycles can include receivables, payables, and inventory.
Examples of activity ratios are inventory turnover ratio, total assets turnover ratio, fixed assets turnover ratio, and accounts receivables turnover ratio.
These ratios can yield insights into the operational efficiency of the company.
There are a few key reasons why a balance sheet is important. Here are a few of them:
A balance sheet lists all assets and liabilities of a company.
With this information, a company can quickly assess whether it has borrowed a large amount of money, whether the assets are not liquid enough, or whether it has enough current cash to fulfill current demands.
A lender will usually require a balance sheet of the company in order to secure a business plan.
Additionally, a company must usually provide a balance sheet to private investors when planning to secure private equity funding.
These are some of the cases in which external parties want to assess and check a company’s financial stability and health, its creditworthiness, and whether the company will be able to settle its short-term debts.
Business owners use these financial ratios to assess the profitability, solvency, liquidity, and turnover of a company and establish ways to improve the financial health of the company.
Some financial ratios need data and information from the balance sheet.
Good and talented employees are always looking for stable and secure companies to work in.
Balance sheets that are disclosed from public companies allow employees a chance to review how much the company has on hand and whether the financial health of the company is in accordance with their expectations from their employers.
Although balance sheets are important financial statements, they do have their limitations. Here are some of them:
It may not provide a full snapshot of the financial health of a company without data from other financial statements.
In order to get a complete understanding of the company, business owners and investors should review other financial statements, such as the income statement and cash flow statement.
The balance sheet only reports the financial position of a company at a specific point in time.
This may not provide an accurate portrayal of the financial health of a company if the market conditions rapidly change or without knowledge of previous cash balance and understanding of industry operating demands.
The data and information included in a balance sheet can sometimes be manipulated by management in order to present a more favorable financial position for the company.
Businesses should be wary of companies that have large discrepancies between their balance sheets and other financial statements.
It is also helpful to pay attention to the footnotes in the balance sheets to check what accounting systems are being used and to look out for red flags.
For instance, accounts receivable should be continually assessed for impairment and adjusted to reveal potential uncollectible accounts.
A company should make estimates and reflect their best guess as a part of the balance sheet if they do not know which receivables a company is likely actually to receive.
Here are some key differences between balance sheets and income statements:
Balance sheets are important financial statements that provide insights into the assets, liabilities, and shareholders’ equity of a company.
It is helpful for business owners to prepare and review balance sheets in order to assess the financial health of their companies.
Balance sheets also play an important role in securing funding from lenders and investors. Additionally, it helps businesses to retain talents.
Although balance sheets are important, they do have their limitations, and business owners must be aware of them.
Some of its limitations are that it is static, has a narrow scope of timing, and is subject to errors and frauds.
A balance sheet is also different from an income statement in several ways, most notably the time frame it covers and the items included.
It is important to understand that balance sheets only provide a snapshot of the financial position of a company at a specific point in time.
In order to get a more accurate understanding of the company, business owners and investors should review other financial statements, such as the income statement and cash flow statement.
Balance sheets include assets, liabilities, and shareholders' equity. Assets are what the company owns, while liabilities are what the company owes. Shareholders' equity is the portion of the business that is owned by the shareholders.
The balance sheet is prepared by the management of the company. The auditor of the company then subjects balance sheets to an audit. Balance sheets of small privately-held businesses might be prepared by the owner of the company or its bookkeeper. On the other hand, balance sheets for mid-size private firms might be prepared internally and then reviewed over by an external accountant.
The balance sheet equation is: Assets = Liabilities + Shareholders' Equity
The balance sheet is used to assess the financial health of a company. Investors and lenders also use it to assess creditworthiness and the availability of assets for collateral.
Balance sheets are typically prepared at the end of set periods (e.g., annually, every quarter). Public companies are required to have a periodic financial statement available to the public. On the other hand, private companies do not need to appeal to shareholders. That is why there is no need to have their financial statements published to the public.
About the Author
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own.
Content sponsored by 11 Financial LLC. 11 Financial is a registered investment adviser located in Lufkin, Texas. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements. 11 Financial’s website is limited to the dissemination of general information pertaining to its advisory services, together with access to additional investment-related information, publications, and links.
For information pertaining to the registration status of 11 Financial, please contact the state securities regulators for those states in which 11 Financial maintains a registration filing. A copy of 11 Financial’s current written disclosure statement discussing 11 Financial’s business operations, services, and fees is available at the SEC’s investment adviser public information website – www.adviserinfo.sec.gov or from 11 Financial upon written request.
11 Financial does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to 11 Financial’s website or incorporated herein, and takes no responsibility therefor. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.
© 2024 Finance Strategists. All rights reserved.
We use cookies to ensure that we give you the best experience on our website. If you continue to use this site we will assume that you are happy with it.
