Reading the Balance Sheet: Assets and Liabilities

A company’s balance sheet is termed a “statement of financial position,” that reveals the assets, liabilities and net worth of a firm. The balance sheet, along with income statement and cash flow statement, is an integral component of financial statements. As an investor or shareholder, it is important that one is aware of the structure of a balance sheet and possesses the knowledge to analyze it thoroughly.

The balance sheet requires the assets to equal the sum of liabilities and shareholders’ equity. Assets used to operate the company need to be balanced with the firm’s financial obligations, as well as the equity investment pooled into the company and its existing repository of earnings. Liabilities and equity support assets. Shareholders’ equity refers to the amount of money invested into the company initially with the retained earnings indicating it as a major source of funding for any business.

A balance sheet presents a snapshot of the financial position of a company at a single point in time.

Assets and its Types

Assets are divided into:

• CURRENT ASSETS – Assets with a lifespan of less than one year that can be transformed into cash are referred to as current assets, and they include cash, cash equivalents, accounts receivables and existing inventory. Non-restricted bank accounts and checks also fall under this category. Cash equivalents can be converted into cash readily. Accounts receivables indicate short-term obligations owed to the company, especially sales completed on credit, and hence are held in current assets until they are paid off. The existing inventory including raw materials, unfinished product goods, and finished goods make up the inventory.
• NON-CURRENT ASSETS – Non-current assets are assets that cannot be converted into cash easily and therefore have a lifespan greater than a single year. Tangible assets such as machinery, hardware, buildings, and land are non-current assets. Even intangible assets including patents or copyright also fall under this category. These resources are known to make or break a company and should not be underestimated at all, especially in economic crunch times.

Every asset undergoes depreciation, and a cost factor is calculated and deducted from the assets, representing the economic cost of its life.

Liabilities and its Types

The assets on the balance sheet are balanced by liabilities that indicate financial obligations of a company to third parties. Long-term liabilities include debts and other financial obligations with terms greater than one year. Current liabilities are the present dues that need to be paid immediately and within one year. Short-term borrowings, including accounts payables or latest interest payment on long-term loans, fall under this category.

Shareholders’ Equity

Shareholders’ equity indicates the money invested in a business. If a company decides to reinvest the earnings after a fiscal year, these retained earnings are transferred from income onto the balance sheet right into the shareholder’s equity account, representing the company’s total net worth.

Reading the Balance Sheet – The Basics

The balance sheet is broken into two main areas. Assets are mentioned on the top, followed by the company’s liabilities and shareholders’ equity. The value of the assets equals the sum of liabilities and shareholders’ equity. The assets and liabilities sections are organized by the current nature of the account too. Accounts are classified from most liquid to least liquid in the assets class. For the liabilities section, accounts are organized from short to long-term obligations.

Here is how you can derive greater understanding of the balance sheet and its construction:

• Financial ratio analysis: This technique uses formulas to gain proper insight into the standing of a company and its operations. Financial ratios can provide an accurate depiction about the financial condition of a company and its operational efficiency. Some ratios require information from multiple financial statements, including the balance sheet and income statement. Financial strength ratios also provide information about the performance of a company to meet its obligations and how they are leveraged. The financial stability of the company comes into view and shows how a company finances itself.
• Activity ratios: Activity ratios focus on current accounts and provide insight on a company’s operating cycle (including receivables, inventory, and payables), thus painting a real picture of the company’s operational efficiency.

In order to better understand the balance sheet, take some advice from the experts. Gain insight into the financial standing of a company through the accounting functions:

• Real-time transactions and the process
• Sales invoicing and bill payments
• Payroll processing
• Routine reporting
• Budgeting and forecasts

A business owner can benefit from leveraging an outsourced accounting services provider who can provide insight around these metrics and figures on the balance sheet in several ways:

• Get periodic consultation to understand the numbers
• Understand the balance sheet along with profit and loss statements
• Define and measure business goals based on your accounts
• Get real-time reports of accounts so that you have actionable data at your fingertips
• Eliminate hiring costs by outsourcing the accounting function
• Avoid the risk of knowledge loss when existing accountants leave your company
• Boost business continuity by storing accounting information securely

Analytix Solutions offers custom solutions for companies ranging from accounting and bookkeeping to more complex requirements. For more information, call us at 781-503-9002 or email us at sales@analytix.com.

Written by

Analytix Editorial Team