HOW TO READ A BALANCE SHEET?
A company’s balance sheet, also known as a “statement of financial position,”. Shows a company’s assets, liabilities, and equity (net worth). The balance sheet, along with the income statement and cash flow statement, is the foundation of any business’ financial statements.
If you are a shareholder of a company or a potential investor. It is important to understand how a balance sheet is structured. How to read and the basics of financial analysis. balance sheet analysis.
KEY POINTS TO REMEMBER
- The balance sheet is an important financial statement that provides an overview of a company’s financial position.
- The balance sheet is divided into two columns, one is equal to the other is zero.
- On the left side write the company’s detailed assets, classified as long-term or short-term.
- The right side contains the company’s liabilities and equity, also segregated into long-term and short-term.
- Equity is the residual value after deducting liabilities from assets.
INTRODUCTION TO BALANCE SHEET
HOW DOES THE BALANCE SHEET WORK?
The balance sheet is divided into two parts. Which, according to the following equation, should be equal or equal to each other. The formula behind the balance sheet is:
Assets = Liabilities + Equity
This means that the assets, or vehicles used to run the business. Are balanced by the financial obligations of the business. As well as the capital contribution to the business and its retained earnings.
Resources are what a company employments to run its commerce. Whereas liabilities and value are the two sources that bolster these resources. Equity, known as equity, in a publicly traded company is the initial amount invested in the company. Plus retained earnings, and is the source of funding for the business. The balance sheet is divided into two main areas.
The assets at the top or left, and below. Or to the right are the liabilities and equity of the business. The balance sheet is also always balanced, where the value of assets equals the combined value of liabilities and equity.
Within each section, the assets and liabilities sections of the balance sheet are organized. By the current state of the account. As a result, on the asset side, accounts are typically ranked from the most liquid to the least liquid. On the liabilities side, the accounts are organized into short-term and long-term loans and other obligations.
It is important to note that the balance sheet is only a snapshot of the financial position of the company at a given point in time.
SHORT-TERM ASSETS (SHORT-TERM)
Current assets have a life of one year or less, which means they can be easily converted to cash. These types of assets include cash and cash equivalents, accounts receivable and inventory.
Cash, the most basic liquid asset, also includes bank accounts and unrestricted checks. Cash equivalents are very safe assets that can be easily converted to cash; The United States Treasury is an example.
Accounts receivable (AR) includes short-term obligations that customers owe to the company. Businesses often sell products or services to customers on credit; These bonds are held in the current account until they are repaid by the customer.
Finally, inventory represents a company’s raw materials, work-in-progress, and finished goods. Depending on the company, the exact composition of the inventory account will vary. For example, a manufacturing company will ship a large amount of raw materials, while a retail company will not. A retailer’s inventory structure typically includes merchandise purchased from manufacturers and wholesalers.
LONG-TERM (LONG-TERM) ASSETS
Long-term assets are assets that are not easily convertible to cash, are expected to convert to cash within one year and/or have a life of more than one year. Such assets can also be intangible, such as goodwill, patents, or copyrights. While these assets are not physical in nature, they are often the resources that can make or break a business – the value of a brand should not be underestimated, for example.
Depreciation is calculated and deducted from most of these assets, representing the economic cost of the asset over its useful life.
Types of liabilities
These are financial obligations that a company owes to a third party.
SHORT-TERM DEBT (SHORT-TERM)
Current liabilities are debts of the business that are due or need to be paid off within one year. This includes short-term loans, such as accounts payable (AP), which are bills and obligations the business owes for the next 12 months (e.g., paying for a home credit purchase. provide). The current portion of long-term loans, such as the final interest payment on a 10-year loan, is also recorded as short-term debt.
LONG-TERM DEBT (LONG-TERM)
Long-term liabilities are debts and other non-debt financial obligations that are due after a period of at least one year from the balance sheet date. For example, a company may issue a bond that matures in several years.
Shareholders’ equity is the initial amount invested in a company. If, at the end of the financial year, a company decides to reinvest net profits into the company (after taxes), these retained earnings will be carried over from the income statement. and equity accounts. This account represents the total net worth of a business. For the balance sheet to be balanced, total assets on one side must equal total liabilities plus equity on the other side.
HOW TO READ BALANCE SHEET
Below is an example of Walmart’s business balance sheet for the fiscal year. As you’ll be able see from the adjust sheet over, Walmart encompasses a sizable cash stream of $14.76 billion in 2022 and over $56.5 billion worth of stock. This reflects the fact that Walmart is a large retailer with many online stores and fulfillment centers with thousands of ready-to-sell items. On the liability side, it’s $55.2 billion in liabilities, possibly money owed to the sellers and suppliers of many of these goods. Subtracting add-up to liabilities from add-up to resources, Walmart incorporates essentially positive net shareholder esteem of more than $83.2 billion.
BALANCE SHEET ANALYSIS WITH RATIOS
As we better understand the balance sheet and its structure, we can review some of the techniques used to analyze the information contained in the balance sheet.
The main technique is the analysis of financial statements ratios.
Financial ratio analysis uses formulas to better understand a business and its operations. The use of financial ratios (such as debt-to-equity (D/E)) can provide a clear picture of the financial position and performance of the business. of the company. It is important to note that some ratios will require information from many financial statements, such as balance sheets and income statements. Looking at Walmart’s balance sheet above, we can see that the debt ratio for 2022 is:
D/E = Total Liabilities / Total Equity = $152,969 / 83,253 = 1.84.
Important ratios that use information can be categorized into liquidity ratios, solvency ratios, financial strength ratios, and operating ratios. Liquidity and dissolvability proportions appear how well a company can pay off its obligations and commitments with existing resources. Financial strength ratios, such as working capital and debt ratios, provide information about a company’s ability to meet its obligations and how to meet those obligations.
These ratios can give investors an idea of a company’s financial stability and how the company is self-funding. Activity ratios focus primarily on current accounts to show how well a business is managing its operating cycle (including accounts receivable, inventory, and accounts payable). These ratios can provide insight into a business’s performance.
What can you tell when you look at a company’s balance sheet?
The balance sheet provides an overview of a company’s assets and liabilities and their relationship to each other. The balance sheet can help answer questions like whether a business has a positive net worth, whether it has enough cash and current assets to cover its obligations, and whether the business high leverage relative to peers in the same industry. Fundamental analysis using financial ratios is also an important toolkit that pulls data directly.
WHAT ARE THE MAIN THINGS FOUND ON A BALANCE SHEET?
The balance sheet includes information about the company’s assets and liabilities as well as the shareholders’ equity. These categories can include short-term assets, such as cash and accounts receivable, inventory, or long-term assets such as real estate, plant and equipment (PP&E). Similarly, a company’s liabilities may include short-term obligations such as accounts payable to suppliers or long-term liabilities such as bank loans or corporate bonds issued by the company. onion.
IS A BALANCE SHEET ALWAYS BALANCED?
Yes, the balance sheet will always be balanced because the equity entry will always be the balance or difference between a company’s total assets and total liabilities. If the company’s assets are worth more than its liabilities, the result is a positive net capital. If liabilities are greater than total net assets, then equity will be negative.
The balance sheet, along with the income statement and cash flow statement, is an important tool for investors to get an overview of a business and its operations. It is a snapshot at a given time of a company’s accounts, including assets, liabilities, and shareholder equity. The purpose of a balance sheet is to give interested parties an idea of the financial position of the business, in addition to showing what the business owns and owes. It is important for all investors to know how to use, analyze and read a balance sheet. A balance sheet can provide insights or reasons to invest in stocks.