A balance sheet shows a company’s assets, liabilities, and shareholders’ equity at a point in time. These financial statements are used to determine a company’s health and financial viability at a particular point in time. A balance sheet is not a predictor of future health, but comparing previous balance sheets can provide insight into a company’s changing fortunes.
Also known as:statement of financial position
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Assessing the health of a company can be difficult. Fortunately, there are financial statements that give investors, shareholders, and employees a glimpse into the inner workings of an organization. One of the most important documents, the balance sheet is a snapshot of the company, showing all the liabilities, assets and shareholder investments at a given moment.
How the balance sheet works
A balance sheet is a financial statement that shows a company’s assets, liabilities, and shareholders’ equity at a point in time. A balance sheet is commonly used to determine the health and financial viability of a company. Think of the balance sheet as the thermometer of your business. A balance sheet shows the health of a company, but only then. While it is not a predictor of future health, a comparison of previous balance sheets can provide insight into the company’s changing fortunes.
A balance sheet attempts to solve the basic accounting equations. The value of a company’s assets must equal its liabilities plus shareholders’ equity. If the numbers are different, you may be missing information, spending too much, or your company’s products and services are not profitable. If assets are less than liabilities and shareholders’ equity, the company is failing.
Components of the balance sheet
A balance sheet has three important items: assets, liabilities and shareholders’ equity.
An asset is anything that can be converted into income for the benefit of the company. The most obvious assets are the products or services that the company produces, also called inventory. Other common assets include cash, cash equivalents, accounts receivable, and investments.
Assets can be classified as current and long-term. Current assets he can liquidate within a year, while long-term assets tend to be held longer and can be depreciated or amortized over time. Long-term assets include real estate, manufacturing equipment, business vehicles, and long-term investments. Trademarks and patents are also considered long-term assets.
If assets are positive, liabilities are negative. Liabilities are money that a company owes or owes to others. Liabilities are also classified into current liabilities and long-term liabilities.
Current liabilities may include salaries, rent payments, utilities, taxes, and monthly payments for equipment and vehicles.
Long-term liabilities can include business loans, mortgage payments, corporate bonds, pension obligations and leases that may extend beyond the current year.
The final element of the balance sheet is shareholders’ equity. Shareholders’ equity is the money invested in the company by the owners or shareholders plus the amount earned by the business plus the capital donated. It can also be called share capital.
To find shareholders’ equity, accountants use a simple formula. Shareholders’ equity equals total assets minus total liabilities. Shareholders’ equity is basically the same as the net worth of the company. If shareholders’ equity is positive, the company is profitable. If negative, it failed at that point.
The balance sheet is structured to list assets, liabilities and shareholders’ equity in that order. Within assets, items are organized by level of liquidity, followed by current assets and long-term assets.
Cash and Cash Equivalents This is money readily available for business in checking and savings accounts.
Securities This includes stocks, commercial papers, Treasury bills and certificates of deposit.
Inventory or Accounts Receivable Physical inventory is the asset of the company that manufactures the product. For services, accounts receivable represent the amount expected to be paid by a company for work already provided.
Prepaid Expenses If the company’s rent, insurance, marketing or advertising has already been paid, it counts as an asset. If not paid, it will be marked as a liability.
Property, plant and equipment, called PP&E in accounting, includes, among others, real estate, office equipment, machinery, buildings, furniture and fleet vehicles.
Intangible Assets If a company produces material protected by copyright, trademark, or patent, those legal rights are considered assets. These are difficult to quantify and may differ from actual values, but should still be considered.
Liabilities are also listed in order of urgent need. Payments due first are listed first.
- short term loan A loan that is repaid within a year is considered a short-term liability.
- accounts payable Recurring payments include equipment leases, materials for production, or ongoing costs such as internet services or advertising.
- accrued expenses Most wages are paid after the work is done, so they are accrued expenses.
- fixed liability Expenses with payment terms exceeding one year are considered long-term liabilities. It covers pension payments, bond principal and interest, and mortgage payments.
The last section of the balance sheet is reserved for shareholders’ equity. This section can be divided into several subcategories.
- common stock. Ordinary shares are a capital investment of the company’s shareholders. If privately owned, this would be money invested by the company owner. For listed companies, this includes all shareholder contributions.
- retained earningsRetained earnings are earnings that are not paid out to shareholders in the form of dividends.
- treasury stock. Treasury stock is stock that a company has bought back from its shareholders. Treasure inventories are often stored for times of recession when businesses may need to raise money quickly.
- preferred stock. Some companies also offer preferred stock. Preferred stock has no market-based value, but offers a greater claim to dividends in liquidation.
- Capital surplus. If a shareholder provides additional capital beyond common or preferred stock, it is considered capital surplus.
Purpose of the balance sheet
A balance sheet shows the health and viability of a company at a particular point in time. A company’s balance sheet can be used for:
- assess risk If a company is looking for investors, the balance sheet can show its current and future value. A balance sheet shows how a company needs to operate by showing its liabilities. Do they need to increase profits or keep more liquid assets?
- gauge efficiency To run a company efficiently, management needs to know how effectively its resources are being used and how much debt is holding them back. The balance sheet is only part of it. Income sheets add more context to your photos.
- leveraged debt If a company is looking to invest heavily in employees, equipment, or real estate, the balance sheet may indicate how much debt the company currently has. A balance sheet can be used to calculate the debt-to-equity ratio. This is a key metric for determining the risk of incurring new debt.
- spot the error If your balance sheet is unbalanced, it may be because some information is missing or incorrect. Finding missing components helps accountants and bookkeepers complete all reports accurately.
Who Needs a Balance Sheet?
A balance sheet is a valuable tool for any business owner, but a must for publicly traded companies. Any C-corporation whose receipts and assets exceed $250,000 must file a tax-included balance sheet and verify that it matches the balance sheet included on Form 1120.
Small businesses are not required to provide a tax-included balance sheet, but shareholders and current and potential employees may request a balance sheet to assess the health of the company.
Who prepares the balance sheet?
The balance sheet, income statement, cash flow statement and equity statement are the four important financial statements. It is usually prepared by the company’s accountant. In small businesses, the bookkeeper or company owner may prepare the balance sheet.
balance sheet timing
As mentioned above, the balance sheet only shows the value and health of the company at that point in time. For this reason, many companies prepare balance sheets several times a year. Used in conjunction with an income statement, a periodic balance sheet can show how a company is growing or slowing down. Most companies complete their balance sheets on a set schedule, such as monthly, quarterly, or yearly.
Who sees the balance sheet?
Outside of company leadership, the balance sheet is a useful tool for many stakeholders. Lenders may require a balance sheet when evaluating creditworthiness, and some small business loans, such as SBA 7(a), require a balance sheet when requesting $350,000 or more. Become. Nonprofit organizations applying for grants may also be required to provide a balance sheet.
If the company is for sale, potential buyers may ask to check the balance sheet to see if the net worth is solid enough to warrant a purchase. Potential employees may also look to it to see if the company is a good fit for their career goals in the long term.
balance sheet limits
A balance sheet can provide a snapshot of a company, but it takes more movement to get an accurate picture of its health. This is why the balance statement is often combined with the income statement and cash flow statement to create a more comprehensive analysis of its viability.
Even if a company completes monthly income and expense reports, weekly spikes in spending can put undue stress on its resources. Similarly, if some accounts receivable could be delayed or forfeited, the company could be temporarily out of balance on its balance sheet.
Another limitation is the valuation of intangible assets. In the case of patents and trademarks, the value can be overstated or understated, creating a false value that is offset by the actual liability.
Key points of the balance sheet
- The balance sheet helps owners and shareholders know whether the company is successful, well managed, and if changes need to be made.
- If a company manufactures chairs and the cost of lumber increases during the quarter, but the price of the chairs remains the same, the balance sheet will show a discrepancy.
- The balance sheet provides a temperature gauge of your company’s health, one reporting period at a time.