The Balance Sheet is a snapshot of the financial condition of the business at a specific time span. It is also called a statement of the financial position. Business managers and entrepreneurs and anyone who is thinking to launch a startup should get adequate knowledge about financial statements and account methods to analyze
- the liquidity (ability to pay current obligations) and
- the solvency (capacity to meet enduring financial commitments)
A Balance sheet is a great help in analyzing and evaluation of the financial health of your business. It is the data that can be shown to your potential investors, current clients, and all those who need to stay informed about the financial affairs of your business.
The Structure of the Balance Sheet
Those who had not studied business or not used to finance and accounting’s might get nuisance with the first look on the balance sheet. You might think it as a complex mathematical intricacy but after getting the basics, it would be far less daunting to understand. It is just a simple table of someone’s assets, liabilities and equity with their values at a particular point in time.
General Sections of the Balance Sheet
A balance sheet consists of three primary sections i.e. assets, liabilities and equity.
Assets are the resources attained by the company to complete operations. It can be either
- Something owned by the business, for instance, money, equipment, goods, shares, buildings, etc.
- Something that is authorized to you but owned by someone else, for instance, loans and credits
Assets are further classified as current and non-current assets. Usually, the balance sheet has current assets placed before the non-current ones. Current assets are more liquid; that means they could be easily converted into cash, trading securities, receivable accounts, supplies, and inventory, etc. Non-current assets are not fast cash but have longer values. These include properties, deposits, equipment and intangible assets such as patents and trademarks.
Liabilities are the company’s obligations or debts such as
- Accounts payable (suppliers)
- Notes and mortgage (banks or financial institutions payable)
- Incurred or accrued expenses
Just like assets, liabilities are also classified into current and non-current categories. Current Liabilities are debts that are due within an operating cycle; usually of twelve months. They have short-term payable span like accrued expenses, accounts payable and CPLTD current portion of long-term debt. Non-current liabilities are long-term obligations that are due within more than a year. Examples are bonds and mortgage payable.
Equity reveals the invested amount in the firm. Two sources of owner’s equity include,
- Money invested by shareholders
- Retained earnings i.e. Amount retained by from the profits. It is an increasing amount of profit developed over the years.
The Balance Sheet Equation
The very simple and spontaneous method that many business managers and owners use to calculate the value of company’s equity is a simple equation;
Equity = Assets – Liabilities
Yes, simply deduct all the liabilities from the assets and you’ll get owner’s equity or net profit amount. To get the asset part on a balance sheet, use following equation;
Assets = Liabilities – Owner’s Equity
The Significance of Balance Sheet Ratios
The reason this financial statement is called “Balance Sheet” is because its two sides always sum up to the same amount. Moreover, this stands for a permanent and true stature of a balance sheet.
For the vital decision-makers of the business i.e. investors and creditors –a balance sheet contains fundamental information about the financial fitness of the company. It indicates about the financial stability through liquidity and solvency ratios.
The current ratio specifies if the business has enough assets to pay off short-term obligations with a simple formula applied;
Current ratio = current assets / current liabilities
It is the favorite ratio of the investors. The product value of current ratio that is above 1 is always acceptable. However, a current ratio that is too high is never recommended since it shows that the company is not using surplus cash to generate other income.
The Quick ratio measures the ability to pay current liabilities using quick assets. They include cash, accounts receivable and trading securities. It is also known as the “Acid test ratio.” The formula is;
Quick ratio = quick assets / current liabilities
Importance of Balance Sheet
Helps in Getting Funds: As it provides info about debt conditions, and the total value of your business assets, this document is critical while you are looking for funding for your business. It provides a clear stance to the potential investors and makes it easier to quickly analyze and come to a decision.
Business Financial Health Analyzer: Entrepreneurs and startup owners can quickly analyze their business growth on a monthly basis through reviewing their balance sheets. With latest accounting software and applications, creating balance sheets is a task of seconds.
Help stay on top of your Finances: It is an efficient tool to ensure that your liabilities do not exceed your assets and therefore, contributes to avoiding financial issues.