Thinking of performing fundamental analysis of a stock? Or simply want to analyse a company and its performance? Or want to calculate the financial ratio?
Whatever would be the case, you would need to go through the company’s balance sheet in the process for sure. Hence, it’s important that you understand the balance sheet in detail.
Let’s start with the balance sheet meaning!
A balance sheet is defined as a financial statement that summarises the assets and liabilities of the company and shareholders’ equity at a specific point in time. It renders a basis for assessing the rates of return and estimating its capital structure.
In simpler terms, it’s a financial statement that gives you an overview of what a company owns and owes, as well as the amount, shareholders have invested in the company.
Among all the three financial statements, the balance sheet is the most important one that represents the financial health of a business. The other two are the income cash flow statement and income statement.
From the above discussion, it is pretty clear that a balance sheet is used to gain insight into a company, its financial status, and financial operations at a specific point in time.
Besides, it is used to calculate the financial ratios of a company along with two other financial statements.
The elements listed on the balance sheet may vary based on the type of industry. However, in general, a balance sheet is divided into three categories. Or you can say, a balance sheet consists of three main items as follows:
Typically, assets are classified into liquid assets and non-liquid assets.
Liquid assets are ones that are either cash or can be easily transformed into cash.
However, non-liquid assets can’t be easily converted into cash. For example, buildings, lands, and equipment. They may also comprise tangible assets such as copyrights, franchise agreements, and patents.
Liabilities are the business’-owned fund that is broken down into current and long-term categories.
Such liability is due within one year and comprises items such as:
Income tax deductions
Accounts payable (supplier invoices)
Medical plan payments
Pension plan contributions
Customer deposits (advance payments for goods or services to be delivered)
Building and equipment rents
Lines of credit
Sales tax and/or goods, and services tax charged on purchases
Such liabilities are ones that are due after a one-year period. These may consist of deferred tax liabilities, any long-term debt such as principal on bonds and interest, and any pension fund liabilities.
Generally, equity is known as shareholders’ equity or owners’ equity. Equity is the remaining from the subtraction of the liabilities from the assets. Retained earnings are the ones retained by the organization. It isn’t paid to shareholders in the form of dividends.
Such earnings are mainly utilized to pay down debt or reinvest in the business to avail of the advantage of growth opportunities such as business expansion.
A balance sheet adheres to a certain accounting equation, where assets are kept on one side while the liabilities + shareholders equity are placed on the other side. Here’s how it looks:
Assets = Liabilities + Shareholder’s Equity
This formula is instinctive: a company needs to settle for all the things it possesses (assets) by either borrowing money (taking on liabilities) or taking it from investors (issuing shareholders' equity).
Since you are reading this, you might be also interested in knowing what is asset turnover ratio and its formula.
An updated and accurate balance sheet is crucial for a business owner seeking equity financing or additional debt, or someone who wants to sell the business and wish to find its net worth.
It’s mandatory for registered businesses to include income statements, balance sheets, and cash flow statements in financial reports to shareholders and tax and regulatory authorities.
Although sole proprietorships and partnerships don’t need to prepare balance sheets as it’s optional for them. However, it’s crucial in determining the health of the business.
Many of you might have been looking for a balance sheet format. So, here we have attached a sample of the TCS balance sheet derived from MoneyControl.