Definition of Balance Sheet
The following article provides an outline for how to read a balance sheet? Reading a Balance sheet rightly helps the users to understand the financial stability and position of a company as a balance sheet is the most important report which shows the financial standings and strength of a company at a point of time by comprising the data of Assets, liabilities, and shareholder’s equity of the company at that point of time (generally Balance sheet is prepared at month end or quarter end or year-end).
Explanation
The balance sheet is basically a snapshot of the financial position and status of a company at a particular time (as on the date) which helps the stake holders to quantify the financial strengths of the company. The balance sheet is prepared based on an equation called Balance Sheet Equation, which is;
This is the principle on which the whole balance sheet is made. Balance sheet records in three proportions; one is the Asset, which will always be equal to the company’s total liabilities as on the date summed up with all the funds acquired from the shareholders accompanied with any retained earnings accumulated by the company.
How to Read a Balance Sheet?
As per the Balance sheet equation, the Balance Sheet could be divided in 3 components and these components could also be sub divided into parts which could be summarised as follows:
- Assets: Current Assets, Non-Current Assets or Long Term Assets
- Liabilities: Current Liabilities, Non-Current Liabilities or Long Term Liabilities
- Shareholder’s Equity: Common Shares & Retained Earnings
To understand the balance sheet, it is vital to understand these components as well as their sub-categories.
1. Assets: Assets are used to operate the business and which provide future economic benefits to the entity. These are classified in two categories:
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- Current Assets: Current Assets are typically liquid assets that could be converted into cash or cash equivalents within one year. Current Assets Include-
- Inventories: The stock in trade is available on the date of the balance sheet which company is used to sell. Inventories include raw material, finished goods, intermediary goods (goods which are still progress to completion), as well as trading goods.
- Accounts Receivable: These are the amounts that have been earned by the company through his sales but not has been received yet, and the bad debt also has been written off from the amount, which is not expected to be received in future.
- Cash & Cash Equivalents: These are the assets that are completely liquid in nature, like cash & bank balance.
- Others may include short term investments, short term advances, prepaid expenses, etc.
- Non-Current Assets (Long Term Assets): Long term assets are the areas where companies have expended the most capital for long term returns. These includes:
- Property, Plant & Equipment: These are the Fixed Assets having more than a year of life i.e., machinery, office equipment, land, building, etc.
- Long Term Investments.
- Intangible Assets i.e., goodwill, patent, know how, etc.
2. Liabilities: These are the expenses that the company owe to others. It could be categorized in two:
- Current Liabilities: These are the liabilities which are need to be payed within 1 year of time. These include short term borrowing, trade payables, interest payables, etc.
- Non-Current liabilities: These are the liabilities which are need to be payed or have a credit period of more than 1 year. These include liabilities that are not covered in current liabilities.
3. Shareholder’s Equity: This is also termed as net worth or the overall value of the company. It includes the common equities which are received from the shareholders which has been issued to them and it also includes Retained Earnings.
- Share Capital & Common Stock: It shows the total value for which investors have invested in the company and the value of stocks that has been issued to shareholders.
- Retained Earnings: These are the funds accumulated through profit remains of companies over a period of running business which has been saved and might be used in the business or paid off as dividend to the shareholders.
Through this information and the data provided in the Notes to Accounts and through different types of ratio analysis, the users can test the financial stands of the business and the efficiency of running the business as well.
Sample Balance Sheet (with Excel Template)
The excel template of the same balance sheet has also been provided.
| Balance Sheets | ||
| (Anonymous Balance Sheet) | ||
| June 30, | 2019 | 2018 |
| Particulars | Amount (In millions $) | Amount (In millions $) |
| Assets | ||
| Current assets: | ||
| Cash and cash equivalents | 11,000.00 | 11,500.00 |
| Short-term investments | 1,20,000.00 | 1,15,000.00 |
| Total cash, cash equivalents, and short-term investments | 1,31,000.00 | 1,26,500.00 |
| Accounts receivable | 30,000.00 | 25,000.00 |
| Inventories | 2,000.00 | 2,500.00 |
| Other | 10,000.00 | 6,750.00 |
| Total current assets | 1,73,000.00 | 1,60,750.00 |
| Property and equipment | 35,000.00 | 30,000.00 |
| Operating lease right-of-use assets | 7,500.00 | 6,700.00 |
| Equity investments | 2,500.00 | 2,000.00 |
| Goodwill | 40,000.00 | 35,000.00 |
| Intangible assets, net | 7,500.00 | 8,000.00 |
| Other long-term assets | 15,000.00 | 7,500.00 |
| Total assets | 2,80,500.00 | 2,49,950.00 |
| Liabilities and stockholders’ equity | ||
| Current liabilities: | ||
| Accounts payable | 9,000.00 | 8,500.00 |
| Current portion of long-term debt | 5,500.00 | 4,000.00 |
| Accrued compensation | 6,500.00 | 6,000.00 |
| Short-term income taxes | 5,500.00 | 2,000.00 |
| Short-term unearned revenue | 30,000.00 | 26,000.00 |
| Other | 10,000.00 | 8,500.00 |
| Total current liabilities | 66,500.00 | 55,000.00 |
| Long-term debt | 65,000.00 | 70,000.00 |
| Long-term income taxes | 30,000.00 | 30,500.00 |
| Long-term unearned revenue | 4,500.00 | 3,500.00 |
| Deferred income taxes | 200 | 600 |
| Operating lease liabilities | 6,000.00 | 5,500.00 |
| Other long-term liabilities | 7,500.00 | 5,000.00 |
| Total liabilities | 1,79,700.00 | 1,70,100.00 |
| Commitments and contingencies | – | – |
| Stockholders’ equity: | ||
| Common stock and paid-in capital | 75,000.00 | 70,000.00 |
| Retained earnings | 26,000.00 | 11,000.00 |
| Accumulated other comprehensive loss | -200 | -1,150.00 |
| Total stockholders’ equity | 1,00,800.00 | 79,850.00 |
| Total liabilities and stockholders’ equity | 2,80,500.00 | 2,49,950.00 |
In the sample balance sheet, we can clearly see that the balance sheet can be segregated in three parts – Assets, Liabilities & Shareholder’s Equity. Where Assets consist of Current Assets (cash & cash equivalents, short-term investments, Account receivables, inventories & others) and Non-Current Assets (Fixed Assets, intangible assets & others) totalling to $ 2,80,500 in Year 2019 & 2,49,950 in year 2018.
The second part is Liabilities consisting of current liabilities (short term accounts payables and other liabilities) & Non-Current Liabilities (long-term liability, other long-term debts) amounting to $ 1, 79,700 in year 2019 & $ 1, 70,700 in year 2018.
The third part is Shareholder’s Equity consisting of common stocks and other retained earnings totalling to $ 1, 00,800 in year 2019 & $ 79,850 in year 2018. Which satisfies the balance sheet equation; for 2019 (same for year 2018)
Assets = Liabilities + Shareholder’s Equity
$ 280500 = $ 179700 + $ 100800
Conclusion
Knowing how to read a balance sheet is really helpful for the users of the financial statement, as statement of profit and loss only shows the profit earned by the company in that period of time whereas the balance sheet shows the proper financial strength and weakness of the company and the capability of the company in making future profitability. This makes the users to take right decision regarding the entity’s course of business. With statement of profit & loss and cash flow statement, the balance sheet becomes the complete financial statements that provide the users and investors with all the relevant information about the business and standing of the business in the market.
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