A balance sheet is a financial statement that reports a company's assets, liabilities and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure. It describes a company's financial position (types and amounts of assets, liabilities, and equity) at a point in time.
A balance sheet is a snapshot of the business at a certain point in time. The first section of a balance sheet shows all the productive assets a firm owns; the second section shows all financing methods used in the business, such as loans, owner's investments and income from the business.
Assets: Assets are resources that a company owns or controls. This can include cash and inventory. While property is also considered an asset, equipment is classified as a long-term asset because it’s value and useful life depreciates over time. Assets are anything that the company has ownership or control over, even if it’s not technically in their financial control just yet (think accounts receivable). They can be divided into current as well as non-current assets or long-term assets.
Liabilities: Liabilities on are debts or obligations of a company. It is the amount that the company owes to its creditors. Liabilities can be divided into current liabilities and long-term liabilities. It is the creditors’ claim on assets. These claims are obligations to provide assets, products, or services to others. A payable is a liability that promises a future outflow of resources. This can be anything from rent and utilities to loans. Liabilities comprise everything the company currently owes on (loans, credit lines, accounts payable).
Shareholders’ Equity: This is how much is invested in the company, or how much of business is owned by investors, and the retained earnings (those that are not paid out to stockholders as dividends) that would be left over if all assets were liquidated and debts were paid.
Owner’s equity is used when the company is a sole proprietorship and shareholders’ equity is used when the company is a corporation. It is also known as book value of the company.
The structure of the balance sheet reflects the accounting equation: assets = liabilities + stockholders' (or owner's) equity.
For internal users, such as employees and managers, the balance sheet is an essential tool to evaluate and manage the financial health and position of a company in a given period of time. Internal users typically use the balance sheet and other financial statements as a means of managing and planning budgets, aligning departments, measuring impact, and other decision making functions. Additionally, balance sheets provide the information needed to understand the liquidity and long-term solvency to further make more informed operational and financing decisions about the business. It is critical for internal users to periodically review their organization's balance sheet to identify issues such as lack of assets, excess of liabilities over assets, or any potential shortcomings that may affect the company in the long run. Internal users also tend to compare balance sheets amongst their competitors to better develop or alter their competitive strategies.
Common external users of the balance sheet are investors, vendors, and government agencies, with each using different types of information in financial statements more relevant. Credit and equity investors rely on the balance sheet to make their investment decisions. The balance sheet and income statement are the two basic sets of financial reports to give an account of a business’ positions of assets, liabilities, and equity at the end of an accounting period, as well as sales, expenses, and income for the accounting period. The debt level, as shown through the company's balance sheet is important to lenders to determine the debt level and credit worthiness. Shareholders will want to look at the equity portion to evaluate retained earnings for equity growth. Vendors on the other hand look at the accounts payable reported on the balance sheet and their ability to pay bills in time. Vendors will be interested in seeing if there are enough cash-convertible assets to cover current liabilities including accounts payable. Current assets are an important indicator of how much trade credit may be extended to the company. Lastly, government agencies including regulatory bodies and taxing authority will look at the balance sheet to monitor the capital-to-assets risk ratios based on the equity section. This is ensure companies in certain industries meet mandatory capital injections measured against total risky business investments.
Resources:
https://mint.intuit.com/blog/investing/balance-sheet/
https://online.hbs.edu/blog/post/how-managers-use-financial-statements
https://quickbooks.intuit.com/ca/resources/marketing/common-external-users-financial-statements/
HTH & Accounting Associates help organizations and business owners with accounting and/or financial consulting services.
For Help with Significance of the Balance Sheet contact us at accounting@thaddeus.org or call us at 909-599-2111.
Thanks for reading
Harshal Choudhari
John Velasco
Sharon Ma
