Balance Sheet is the financial statement of a company that includes assets, liabilities, equity capital, total debt, etc. at a point in time. For the balance sheet to reflect the true picture, both heads (liabilities & assets) should tally (Assets = Liabilities + Equity).
Because the balance sheet informs the reader of a company’s financial position as of one moment in time, it allows someone—like a creditor—to see what a company owns as well as what it owes to other parties as of the date indicated in the heading. This is valuable information to the banker who wants to determine whether or not a company qualifies for additional credit or loans. Others who would be interested in the balance sheet include current investors, potential investors, company management, suppliers, some customers, competitors, government agencies, and labour unions.
Fulfilling statutory compliances
The balance sheet is a very important financial statement for many reasons. It can be looked at on its own, and in conjunction with other statements like the income statement and cash flow statement to get a full picture of a company’s health. 4 important takeaways includes :
Liquidity : Comparing a company’s current assets to its current liabilities provides a picture of liquidity. Current assets should be greater than current liabilities so the company can cover its short-term obligations. The Current Ratio and Quick Ratio are examples of liquidity financial metrics.
Leverage : Looking at how a company is financed indicates how much leverage it has, which in turn indicates how much financial risk the company is taking. Comparing debt to equity and debt to total capital are common ways of assessing leverage on the balance sheet.
Efficiency : By using the income statement in connection with the balance sheet it’s possible to assess how efficiently a company uses its assets. For example, dividing revenue into fixed assets produces the Asset Turnover Ratio to indicate how efficiently the company turns assets into revenue. Additionally, the working capital cycle shows how well a company manages its cash in the short term.
Rates of Return : The balance sheet can be used to evaluate how well a company generates returns. For example, dividing net income into shareholders’ equity produces Return on Equity (ROE), and dividing net income into total assets produces Return on Assets (ROA), and dividing net income into debt plus equity results in Return on Invested Capital (ROIC).
Types of balance sheet
There are several balance sheet formats available. The more common is the classified, common size, comparative, and vertical balance sheets. They are explained as follows:
Classified balance sheet : This format presents information about an entity’s assets, liabilities, and shareholders’ equity that is aggregated (or “classified”) into subcategories of accounts. It is the most common type of balance sheet presentation and does a good job of consolidating a large number of individual accounts into a format that is eminently readable. Accountants should present balance sheet information in the same classification structure over multiple periods, to make the information in the periods more comparable.
Common size balance sheet : This format presents not only the standard information contained in a balance sheet but also a column that notes the same information as a percentage of the total assets (for asset line items) or as a percentage of total liabilities and shareholders’ equity (for liability or shareholders’ equity line items). It is useful for constructing trend lines to examine the relative changes in the size of different accounts.
Comparative balance sheet : This format presents side-by-side information about an entity’s assets, liabilities, and shareholders’ equity as of multiple points in time. For example, a comparative balance sheet could present the balance sheet as of the end of each year for the past three years. It is useful for highlighting changes over time.
Vertical balance sheet : This format is one in which the balance sheet presentation format is a single column of numbers, beginning with asset line items, followed by liability line items, and ending with shareholders’ equity line items. Within each of these categories, line items are presented in decreasing order of liquidity.
