What is a Balance Sheet? Why is it so important?
A Balance sheet may be the most mentioned thing in these accounting articles. It’s also amongst the most crucial elements in finances and investments. Both people in and outside of the business use these to calculate how well the financial activity is doing currently.
Amongst the financial statements, Balance reports are the most important. They list all things that the company owed and owned during the reported period. These reports are usually compiled each month, and they list all the property, debt, and so forth. In short, that’s how valuable the business is.
What is a Balance Sheet?
The Balance sheet is a pecuniary approval of the business’s rate calculated for some period. Usually, these are calculated for each month after it ended. Since each of these regular statements lists the same collection of accounts, you can clearly see a trend happening currently with the entity’s resources.
Anyhow, there are normally 3 sorts of accounts within the Balance sheet:
- Assets.
- Liabilities.
- Equities.
They are listed in this order from top to bottom in a sheet. Moreover, each component is then divided into many more components, depending on what each section actually constitutes of. As a result, you get a rather accurate description of what the company owns, what it owes to others, and the combination thereof.
The very value of the company (at least as far as accountants and analysts are concerned) lies within the assets. Assets are actually a combination of the company’s equity and liabilities.
What does it consist of?
Equity, liabilities & assets are the three major parts of any Balance sheet. Counting them after each month is not just a way of calculating the company’s well-being, but also figuring out whether the financial entries done throughout that month are accurate, up-to-date and, well, balanced.
Assets
Assets are, generally speaking, all the property, possessions, and other valuable stuff an entity could have. Securities, cash, accounts receivable (all the money the company is owed), intellectual property, and goods are all assets. Although these obviously show how prosperous the business is, it’s not all.
Liabilities
Liabilities, for their part, live up to their name. It’s everything the company uses to make profits but doesn’t actually own. Debts, loans, various accounts payable (not yet paid money transfers), interest, and so on are all liabilities. Although they seem like a bad thing to have, they are still largely used by the company. Loans are clearly used by the business for its own benefit. But even unpaid salaries are still technically a sign that a company is running.
Equity
Equity, aka shareholder equity, is a specific segment of a Balance sheet. Basically, it unites all the funds minus the liabilities. As a result, equity is property the company can pay off at any time and share amongst its stockholders. Equity is represented as an appropriate sort of property classified into several types. Assets show all the usable possessions. The liabilities show a portion of those that isn’t technically owned by the company. So, equity shows which resources belong to the company.
They aren’t listed again as they were in the resources category. Instead, they are divided into different types of stock, retained earnings, and other groups. These are supposed to answer the question of ‘where this property came from. If you look at the very bottom of this section, you’ll see total assets and total equity + liabilities.
You should note that the equity and liabilities add up to total assets. If they don’t, then something is wrong with this financial statement or perhaps entries done throughout the reported month.
How are they arranged?
The three main categories of financial accounts – assets, liabilities & equity – are listed on the Balance sheet one after the other. Each section is then sorted into many smaller categories, which are then sorted into even smaller transaction or entry types until you sort them all into as many categories as desired.
For each of these categories, there is a calculated value. Normally, positive entries (accounts with existing value) are listed as usual, while negative entries (expenditures, usually) are put into round brackets. After each category is accounted for, there is a ‘total’ entry of assets, liabilities, and equity respectively.
Regardless, the list has a simple value: account names are listed on the left; their value is listed on the right. This ensures comprehension.
What use are Balance Sheets?
Balance sheets are obviously invaluable for the companies that compile them. By producing these each month, businesses put all of their eggs in the same basket and see how much each of them is worth individually and together. Moreover, such compilations are good for finding mistakes in your accounting.
Error detection
These sheets can be quite complex. Even so, each component is carefully sorted into its own category. To calculate the value of this category, you need to go through each transaction and account for the month (or possibly a longer period of time), add them up, and put the resulting worth on paper.
Do the same for each of these and you’ll get a comprehensive list of everything the business has at its disposal. Essentially, if liabilities and equity don’t equal funds on the sheet, it means there’s a problem either with numbers on the reports or with entries used to compile it.
Going through such procedures is a good way of makings sure your accounting is accurate and up-to-date.
Analysis
Many people are highly interested in analyzing the Balance sheets for their own purposes. The goals might be different, but this analysis usually has much to do with monitoring the financial health and prosperity of the business.
On its own, this list of monetary property can’t tell you much of what the specific business is going through currently. When people try to figure out whether the company is doing well, they take reports from several consecutive periods. A 6-month streak of sheets gives a much better picture of what’s going to happen to this company in the nearest future.
Balance sheets aren’t likely to be manipulated by whoever writes them, so it’s a good indicator of a current trend. This information is then used to make decisions, both by companies themselves and by potential investors who seek to become shareholders and share in the success.
Analysis
Many analysts look into Balance sheets to make investment decisions regarding the specific company. The most relevant one is whether one should buy their shares or not. But how is it done, exactly?
Again, these financial statements aren’t much help on their own. Their power is in comparative analysis against similar statements from earlier on or against Balance sheets from other financial activities (if you’re looking to invest in an economic niche and seek the best candidate).
The usual method is to compare sheets from several consecutive months and combine them into some sort of a trend. This is done by registering how assets, liabilities, and equity changed from start to end of the span of time chosen by you. There are many ways you can unravel these parameters, but looking at the difference in liabilities and equity is a good way to start.
Namely, if total liabilities are bigger in value compared to equity (and stay this way), then this company might not be the best candidate for investment. It shows that it can’t support its own weight with what it owns.
Obviously, you can’t just go ahead and know everything about the company just from their monthly reports. They are good for seeing the general picture and as a starting point for a full-blown research. Professional analysts utilize other financial statements in addition to Balance sheets, as well as use indicators created specifically to do a technical and fundamental business analysis and their stock.
The same goes for companies themselves. They keep tabs on their well-being more than anyone else, and for a similar reason, too. Investors and analysts go through this data to try and earn money. Companies see if they can maximize revenue and minimize losses by managing their expenses and prioritizing sources that earn them more money. They can’t do any of that unless they know exactly where the money goes to and comes from.
Shortcomings of the Balance Sheets
Balance sheets are useful in many ways. Not least among them is verifying trends and analyzing the companies that create them. Despite that, they shouldn’t be perceived as the best sources of information on businesses and their stock. Balance sheets are supposed to be the foundation of your thesis and not its bulk.
It would be a mistake to make an investment into the company stock based solely on several periods of Balance statements. Although it gives you the main idea of what’s going on with the issuer business, it is by no means an indicator of success (or at least it’s not the only indicator). The stock can still grow in value even if the company that issues it takes on more and more loans. It’s critical to look into other indicators as well.