A balance sheet of a company shows information about its assets, liabilities, and owner’s equity. If you are an investor you must be aware of what is on balance sheet of a firm. That is how you will know whether it is a good option to invest in a particular business firm or not.
What’s on a balance sheet is not only critical for the investors but it also helps the organization to adapt accordingly and implement necessary changes for future growth.
In this article, I will explain the importance of the balance sheet for personal finance, what is on balance sheet, and how to read a balance sheet?
Let’s dive in…
What is a Balance Sheet?
To put it simply, what is on a balance sheet shows information of what a company owns and what it owes. It shows the net worth of a company and its financial situation at a particular point in time.
The balance sheet represents the total value of assets of a company and how those assets are financed. If those assets are financed through debt, it’s not a good idea to invest in that company, but if those assets are financed by equity, you should probably start looking into the other details as this company can be a good investment.
Importance of a Balance Sheet
What’s on a balance sheet is very important, whether you are a business owner or a potential investor. Learning about the book value of a business helps you make better decisions. Let’s see how the information on a balance sheet can help you.
Let’s suppose you are running a business, and at a certain point in time, you decide to learn about the performance of your company. You demand the balance sheet.
Looking at what’s on the balance sheet of your company will give you the key information about if your policies and approach to the business are good or you need to make some changes.
If your Assets are financed by equity and not by liabilities then you are on the good side of the business at that particular point in time. If the value of your assets is equal to your liabilities + equity you are also good at that point.
However, if it is not the case, then you need to think about what can you do to make your company progress, doubling down on successes, correcting failures, and exploring new opportunities.
Now let’s assume another scenario, now you are a potential investor in a business and you want to learn whether or not you should be putting your hard-earned money into a business.
What is on a balance sheet will give you insights into the firm’s financial situation, it helps you understand whether it is wise to invest in the business or not.
Important: Without a doubt, what is on the balance sheet is very important, but it is only a snapshot of the company’s net worth at a particular time, it is based on the past data, and what is in the past doesn’t guarantee the future performance.
What is the Balance Sheet Equation?
As the balance sheet contains a lot of information, it can be better understood with a simple equation.
Assets= Liabilities + Equity
If both sides of the equation are balanced, the overall financial situation of the business is good. You can rearrange this equation to find other key metrics.
Equity= Assets – Liabilities
Liabilities = Assets – Equities
What is On Balance Sheet?
Now that we know exactly about the balance sheet and how important it is for your business or for investment purposes, we should move forward to see what is on balance sheet to get in-depth information.
You will find three main pieces of information on a balance sheet, which have subcategories that I will explain below. The main categories are
- Owner’s Equity
Assets in a Balance Sheet
There are two types of Assets
- Current Assets
- Non-Current Assets
Current Assets in a Balance Sheet
Current Assets, just as the name indicates, are the assets that a company has right now, in the form of cash or in the form of investments that can be converted into cash almost immediately.
Current Assets of the company are represented by
- Cash and cash equivalent: Cash that a company has in hand, or in the form of investments that can be converted to cash without a delay, like bonds, treasury bills with a maturity date of fewer than 3 months
- Accounts Receivable: Due payments for goods or services provided by the company from the customer.
- Inventory: Includes the products ready for sale or the raw material that is used for production.
So by using the data available on a balance sheet, you can get valuable information about the company. Cash is a very important asset. The more a company has Cash in hand the better it is in its financial situation, Cash equivalents are also a great asset, like US Treasuries, these can be converted into cash easily.
AR or Accounts Receivables are also very important. If you are running a business you should surely know that sometimes you have to deliver your services or goods on credit. So your clients owe you money for that. This is also a form of your current assets as you will receive this money shortly.
Inventory is the third form of current assets, it is everything that you have as a raw material that you will use to produce your product as well as the finished products that are ready for sale.
Non-Current Assets in a Balance Sheet
For easy understanding, everything or every asset in a balance sheet that is not cash or can not be converted to cash immediately is classified as a non-current asset.
If a business has assets that are expected to be converted to cash within a year or over a year then these are considered non-current assets. For example production units, machines, computers, buildings, land, etc. These assets are also categorized as tangible assets.
A business also has non-tangible assets. Like a brand name, it is not converted to cash easily and you don’t see it physically, but it plays a vital role in the development or growth of the business.
If you are investing in a business, you should not underestimate the brand value, goodwill, or copyrights of a company.
Liabilities in a Balance Sheet
Once you have learned about the assets of a company, you should then move to understand the liabilities that a company holds. This is the second component of a balance sheet. Liability shows what a company owes or the debt.
Tailed negative (-) in a balance sheet, a liability show what does the company has to pay to a debtor.
Just like the assets, liabilities are also categorized as current and non-current on a balance sheet. Let’s talk about them in detail.
Current Liabilities on a Balance Sheet
These are the due payments that a business has to pay within the period of one year. These are mostly paid monthly or quarterly. A business generating enough revenue can easily handle current liabilities as it does not have to take loans for them.
Some of the current liabilities include:
- Utility bills
- Payroll expenses
- Account Payables
- Debt financing
As you can see, these payments need to be paid within a year, these are short-term payments due on a business. Now let’s talk about the long-term liabilities that a business owes.
Non- Current liabilities in a balance sheet
These are the long-term payables or debts. If a company has to return payments or pay for something not within the period of one year, these due payments are called non-current liabilities in a balance sheet.
examples of some non-current liabilities include:
- Bonds Payables
- Provision of pensions
Now let’s move on to the final component of a balance sheet.
Equity on a Balance Sheet
Equity is basically the investment of the owner. Everything that belongs to the owner after the liabilities are accounted for. Now equity can be in two forms. First, in the form of your initial investment in the form of money, or assets to claim the ownership of the business. Which can be in the form of shares.
Second is the form of earnings or returns that are retained by the company. Equity goes up when the company is profitable and it goes down when the company is at loss or when it has to pay dividends.
Let’s suppose you have bought a machine of $1000 dollars for your business, which is now an asset. You have acquired a loan from the bank of $800 which is now your liability as you have to pay it back to the bank, you have invested $200 from your own money, this will be your equity in the business.
Balance Sheet Example
You will be able to understand it better by looking at what is on a balance sheet example below. This is the balance sheet released by Apple Inc. and contains the details of their Assets, Liabilities, and Shareholder Equity at a particular time.
As you can see that Apple has assets valuing $351,002 in the year 2021 the liabilities that the company owes are $28,7912, and total equity is $63,090.
What do you think after looking at this balance sheet? Is this business sheet in balance?
What does The Balance Sheet Tell you about?
Now, at this point, we are well informed about the balance sheet, what is on a balance sheet and how to read the balance sheet correctly. This would be the final piece of information that you require. Why the information on a balance sheet is important?
Importance of a balance sheet
Liquidity means cash or the ease of converting assets into cash. When you compare a company’s current assets with its current liabilities your get a clear picture of the liquidity.
If the current liabilities of a business are greater than its current assets this means that the company will not be able to pay short-term payments.
If the balance sheet indicates that the company has more liabilities, this shows that the company has less financial freedom and it can not take risks. The more the debt the less is the financial freedom.
Rates of Return:
The balance sheet also indicates how much revenue a company is generating. For example, dividing net income by shareholders’ equity produces Return on Equity (ROE), and dividing net income by total assets produces Return on Assets (ROA).
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Whether you are a business owner, an employee, or an investor, what is on a balance sheet is of great importance. The financial health of a business is represented by a balance sheet. If you do not have this information it would be hard to figure out whether your business is growing or not.
I hope this article was helpful and you have got all the information about what is on a balance sheet and how to understand it. Let me know in the comments if you have any questions.