What Is a Balance Sheet Used For?
Every firm has three basic financial statements – the balance sheet, the income statement and the cash flow statement. The balance sheet is the most fundamental of these three, and it captures the most information about the firm, explains Accounting Coach.com. If you check only one document about a firm, it should be its balance sheet.
Balance Sheet Basics
The balance sheet of a company consists of two sides. On one side, all assets of the firm are listed, along with their dollar values. On the other side, the balance sheet equation details the liabilities and shareholder equity. Everything that the firm owes is a liability, including money owed to suppliers, banks, workers as well as other claimants, such as the federal and local tax authorities.
The sum of assets equals the sum of liabilities, plus shareholder equity. This is because everything that is owned is bought with money that came either from the shareholders or lenders. These are the only two sources of cash for a firm at the time it is founded. As the firm accumulates profits later on, these are either distributed to shareholders or folded back into the shareholder equity in the balance sheet, and the basic equation remains intact.
A Listing of Assets
The balance sheet provides a good idea about the capabilities of a firm. The asset side of the balance sheet lists all liquid assets such as cash, bonds and stocks and therefore helps the reader understand how much money the firm can come up with in the immediate future to pay bills and invest in new ventures.
Other assets on the balance sheet that are less desirable include receivables and prepaid expenses, which are far harder to turn into cash on short notice. The amount of fixed investments such as buildings, factories and equipment also tell key stories about the firm.
A Listing of Liabilities
The liabilities section of the balance sheet is where you can see upcoming as well as long-term obligations. Comparing this section with assets tells both internal as well as external stakeholders whether the firm is likely to run into trouble. Short-term liabilities are those coming due in less than a year, while the firm has a year or more to pay obligations listed under long-term liabilities.
If short-term liabilities exceed the sum of liquid assets, the firm could have a hard time paying upcoming bills. Long-term liabilities, such as bank loans and bonds payable, also hold key clues about the money that must be spent over the coming years to avoid default.
Finding Financial Ratios
You can calculate many ratios by dividing one key figure from the balance sheet by another, according to Net MBA.com. The quick ratio, for example, equals short-term assets divided by short-term liabilities. A ratio below 1 points to trouble and possible difficulties in making upcoming payments.
The debt-to-asset ratio, which is total debt divided by total assets, tells you how reliant the firm is on borrowing as opposed to shareholder equity. Such ratios make it easy to compare one firm to another, while also analyzing how the firm has done over time.
A comparison of this year's quick ratio to last year's tells you whether the company is doing a better or worse job matching assets and liabilities.