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What Is Balance Sheet
A balance sheet is a type of financial statement that is used to report an organization's so-called "book value." This value can be determined by deducting the total amount of the company's liabilities and shareholder equity from the total amount of the company's assets.
A balance sheet provides both internal and external analysts with a snapshot of how a company is performing in the period in which it is currently operating, how it performed in the period in which it most recently operated, and how it anticipates performing in the period most immediately ahead of it. Because of this, balance sheets are an essential tool for individual and institutional investors, key stakeholders within an organisation, and any outside regulators who need to see the status of an organisation during specific periods of time.
Who analyzes balance sheets and why?
The balance sheet is the document that one should consult first when seeking information about the financial health of a company. Investors will use it to evaluate the potential of a company. Loan officers are interested in learning about the company's current debt profile and determining whether or not the company is a good candidate for a loan. The company's vendors want to know whether or not they can count on getting paid by this business. The balance sheet could be reviewed by government agencies for a variety of reasons, including compliance and tax purposes.
Proforma of Balance Sheet
Let's Get A Better Grip On The Balance Sheet's Individual Elements.
A) Assets
An asset is anything that a company owns that has some amount of measurable value, which means that it could be sold in order to generate cash and be used for something else. They are the tangible and intangible assets that are owned by the company.
The term "assets" can be subdivided even further into "current assets" and "non-current assets."
Current Assets:
Current assets, also known as short-term assets, are those that a business typically anticipates being able to convert into cash within the next year. Examples of current assets include cash and cash equivalents, accounts receivable, prepaid expenses, inventory, and marketable securities.
1) Cash and cash equivalents:
Because it is thought to be the form of assets that can be converted into cash the quickest, the balance sheet positions it in the top left corner. Cash and cash equivalents are considered to be the same thing because, for the most part, cash equivalents consist of assets with maturities of less than three months or that can be liquidated on very short notice.
2) Accounts receivable:
It is the amount of sales that have been carried out on credit but have not yet been collected as of the date that the balance sheet was prepared. This figure is presented after deducting all of the provisions that were made to account for questionable accounts (high probability of becoming bad debt). In the event that entities are successful in collecting the receivables, the value of their accounts receivable will decrease, while their cash reserves will increase.
3) Inventory:
It is a representation of the amount of money that has been invested in the company in the form of finished goods, goods that are still in the process of being finished, and raw materials. The value of this account is moved to the income statement in the form of cost of goods sold in accordance with the matching principle whenever sales are acknowledged. This happens when the matching principle is applied.
4) Other current assets:
Other current assets is the default classification for general ledger accounts classified as "current assets." Cash, marketable securities, accounts receivable, inventory, and prepaid expenses are not included. Because these major accounts are itemised separately on the balance sheet and typically contain material amounts that should be tracked separately, they are not included in the other current assets classification.
Non-current Assets:
Non-current assets, also known as fixed assets or long-term assets, are investments that a company does not anticipate converting into cash in the near future. Examples of non-current assets include real estate, machinery, patents, trademarks, and other forms of intellectual property.
1) Long-term marketable securities:
Marketable debt securities are held as short-term investments, and it is anticipated that they will be sold within the next twelve months. If it is anticipated that a debt security will be held for more than one year, then it should be categorised as a long-term investment on the balance sheet of the company.
2) Property Plant and Equipment:
It is the section of a company's books that records all of its tangible fixed assets. Buildings, machinery, and other types of equipment are the most common components of PP&E. PP&E is recorded on the net of depreciation, with the exception of land, which is treated differently.
3) Goodwill and Intangible assets:
When accounting for a company's fixed assets, it takes into consideration all of the intangible assets that the company possesses. One can classify these assets as either identifiable or unidentifiable intangible assets depending on their level of specificity. Identifiable intangible assets include things like trademarks and licences, whereas unidentifiable intangible assets include things like goodwill and the value of a brand. Patents and licences are examples of identifiable intangible assets.
4) Other non-current assets:
Other Non-Current Assets is a heading that should be used for any assets that do not fall into the categories of Current Assets, Fixed Assets, or Investment Assets.
B) Liabilities:
A debt that a business or other organisation has to pay back to another party is considered a liability for that entity. This could be a reference to taxes payable, money owed to suppliers, bonds payable, or payroll expenses. Other possible references include rent and utility payments, debt payments, and debt payments.
In the same way that assets can be split into current and non-current categories
Current Liabilities:
Liabilities that are considered current or short-term are typically those that are due within one year. Examples of current liabilities include accounts payable and other expenses that have been accrued.
1) Accounts payable:
It is the monetary amount that a business is obligated to pay to its suppliers for any goods or services that were obtained on credit and represents the dollar value of that obligation. When debts are paid off, the value of accounts payable and cash accounts both decrease by the same amount.
2) Accrued expenses:
Accrued expenses are costs that a business has incurred, such as employee compensation or utility bills, but for which payment has not yet been made. This is most commonly the case because the company's invoice is still in the process of being processed.
3) Current portion of long-term debt:
This account is a representation of the portion of the long-term debt that is due to be repaid within the next calendar year. In essence, the principal payment that is due the following year is accounted for under this head. The debt amortisation schedule can be used to derive this information. This account may be represented separately in some circumstances, and its balance may be included as a component of the long-term debt that falls under the non-current liabilities heading.
4) Short Term Debt:
Short-term debt securities have maturity dates that are within the next year's time frame, which means they will be called due soon (including the current portion of long-term debt).
5) Other current liabilities:
Other current liabilities are the residual liabilities of an organisation that are not classified within one of the other current liability accounts. These liabilities are not included in any of the other current liability accounts. It is a line item in the balance sheet that aggregates several current liability accounts that are too minor to report separately. This line item is called the current liability total. It is typically the last line item that is stated within the section of the balance sheet that is devoted to current liabilities.
Non-current Liabilities:
Non-current liabilities, also known as long term liabilities, are those debts that a company does not anticipate being able to repay within the next year. Typically, these commitments extend over an extended period of time and take the form of loans, leases, or bonds payable.
1) Deferred revenue (non-current):
Deferred revenue, also known as "unearned revenue," is the term used to refer to customer payments received in advance by a company for goods or services that have not yet been delivered.
2) Right of Use (ROU) Lease:
When a lease is recorded, it will be reflected on the balance sheet as both a right-of-use asset (ROU) and a lease liability. The ROU asset represents control of the asset throughout the term of the lease contract, whereas the lease liability is the obligation to make payments over the course of the term of the lease contract.
3) Deferred Tax:
Deferred taxes are the result of temporary timing discrepancies between the tax expense recorded in accordance with GAAP and the actual taxes paid; however, these temporary timing differences between book and tax accounting will eventually unwind to zero over time and cause deferred taxes to be eliminated.
4) Long-term debt:
Any debt obligations with maturity dates that do not come due for at least one year, i.e. maturity exceeds twelve months, are considered to be long-term debt. This type of debt is also referred to as senior debt.
C) Shareholders’ Equity:
The term "shareholders' equity" is commonly used to refer to a company's net worth. This term describes the sum of money that would remain after all of the company's assets were sold and its liabilities were paid off. No matter whether they are public or private owners, shareholders are the rightful owners of the company's equity.
In the same way that a company's assets must match its liabilities plus its shareholders' equity, the equity of a company's shareholders can be represented by the following equation: Equity of Shareholders equals Assets minus Liabilities of the Company.
1) Common stock:
It is a representation of the total amount of money that the shareholders have invested in the company. Share capital can be broken down into two categories: authorized share capital and paid-up share capital. Paid-up share capital is the actual number of shares that have been issued to shareholders, while authorized share capital is the maximum number of shares that a company is permitted to issue. A company's authorized share capital can never exceed the paid-up share capital. Until there are subsequent rounds of equity infusion to fund business requirements, paid-up share capital will typically remain constant over the course of the time period in question.
2) Preferred stock:
Preferred stock is a type of equity capital that is frequently regarded as a hybrid investment due to the fact that it combines aspects of common equity with those of debt.
3) Treasury stock:
Treasury stock is a contra-equity account that happens when a company buys back shares it has already given out. This can be done on a regular basis or just once (and those shares are no longer available to be traded in the open markets).
4) Retained earnings:
It is the portion of the net income that is retained in the books of the company over a period of time. In the event that the business generates a profit, any portion of the net income that is left over after paying dividends is transferred to this account. In the event of losses, on the other hand, it will lead to a decline in the amount of earnings retained.
FAQ (Frequently Question Asked)
What is a balance sheet?
A balance sheet is a financial statement that provides a snapshot of a company's financial position at a specific point in time. It is also known as the statement of financial position. The balance sheet presents the company's assets, liabilities, and shareholders' equity. It offers a summary of what the company owns, owes, and the shareholders' investment.
What is the purpose of a balance sheet?
The balance sheet serves several purposes. Firstly, it helps stakeholders assess the company's financial health and stability. Investors and creditors analyze the balance sheet to evaluate the company's ability to generate cash flows, repay debts, and provide a return on investment. Secondly, it assists management in making informed decisions regarding resource allocation, capital structure, and growth strategies. Lastly, it provides a basis for comparison over time and against industry benchmarks.
What are assets on a balance sheet?
Assets are economic resources controlled by the company as a result of past transactions, and they have expected future economic benefits. Assets on a balance sheet are categorized into current assets and non-current (or long-term) assets. Current assets are those expected to be converted into cash or used up within one year, while non-current assets are expected to provide economic benefits for more than one year.
What are liabilities on a balance sheet?
Liabilities represent the company's obligations or debts that arise from past transactions and require future economic sacrifices. Similar to assets, liabilities are classified into current liabilities and non-current (or long-term) liabilities. Current liabilities are obligations expected to be settled within one year, while non-current liabilities are those due for payment beyond one year.
What is shareholders' equity on a balance sheet?
Shareholders' equity represents the residual interest in the company's assets after deducting liabilities. It represents the shareholders' investment in the company and includes the initial capital contributed by shareholders, retained earnings (profits reinvested in the business), and other equity components like additional paid-in capital, treasury stock, and accumulated other comprehensive income.
How is a balance sheet structured?
A balance sheet is structured in a way that reflects the accounting equation: Assets = Liabilities + Shareholders' Equity. The left side of the balance sheet presents assets, which are further divided into current assets (listed first) and non-current assets. The right side of the balance sheet presents liabilities, which are similarly divided into current liabilities (listed first) and non-current liabilities. Shareholders' equity is listed below liabilities.
What is the importance of the balance sheet equation?
The balance sheet equation (Assets = Liabilities + Shareholders' Equity) ensures that the financial statement is balanced. It provides a fundamental framework for understanding how resources are financed and highlights the relationship between the sources of funds (liabilities and equity) and the uses of funds (assets). If the equation does not balance, it indicates an error in the financial statements or a discrepancy in the company's records.
How often is a balance sheet prepared?
Balance sheets are typically prepared at the end of each accounting period, such as monthly, quarterly, or annually. The frequency of balance sheet preparation depends on the reporting requirements and the needs of the company and its stakeholders. Some companies may prepare interim balance sheets to provide updates on their financial position between the annual reporting periods.
How can a balance sheet be used for analysis?
Balance sheets are essential for financial analysis as they provide insights into a company's financial health. They can be used to calculate various financial ratios and metrics that assess liquidity, solvency, efficiency, and profitability. Examples of commonly used ratios include the current ratio, debt-to-equity ratio, return on assets, and return on equity. These ratioshelp analysts and stakeholders assess the company's ability to meet its short-term obligations, manage its debts, generate profits, and utilize its assets effectively.
What are some limitations of a balance sheet?
While balance sheets are valuable financial statements, they have certain limitations. First, they provide a snapshot of the company's financial position at a specific point in time, and they do not reflect the company's performance or financial changes throughout the reporting period. Second, balance sheets rely on historical cost accounting, which may not reflect the current market value of assets and liabilities. Additionally, certain assets, such as intellectual property or brand value, may not be adequately represented on the balance sheet. Moreover, companies may have off-balance-sheet arrangements or contingent liabilities that are not included in the balance sheet. Therefore, it is important to consider these limitations and complement balance sheet analysis with other financial statements and qualitative information for a comprehensive understanding of a company's financial position.
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