Balance Sheet Explanation, Components, and Examples

What Is a Balance Sheet?

The term balance sheet refers to a financial statement that reports a company’s assets, liabilities, and shareholder equity at a specific point in time. Balance sheets provide the basis for computing rates of return for investors and evaluating a company’s capital structure.

 

In short, the balance sheet is a financial statement that provides a snapshot of what a company owns and owes, as well as the amount invested by shareholders. Balance sheets can be used with other important financial statements to conduct fundamental analysis or calculate financial ratios.

How Balance Sheets Work

The balance sheet provides an overview of the state of a company's finances at a moment in time. It cannot give a sense of the trends playing out over a longer period on its own. For this reason, the balance sheet should be compared with those of previous periods.

 

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Special Considerations

As noted above, you can find information about assets, liabilities, and shareholder equity on a company's balance sheet. The assets should always equal the liabilities and shareholder equity. This means that the balance sheet should always balance, hence the name. If they don't balance, there may be some problems, including incorrect or misplaced data, inventory or exchange rate errors, or miscalculations.1

 

Each category consists of several smaller accounts that break down the specifics of a company's finances. These accounts vary widely by industry, and the same terms can have different implications depending on the nature of the business. But there are a few common components that investors are likely to come across.

Components of a Balance Sheet
Assets

Accounts within this segment are listed from top to bottom in order of their liquidity. This is the ease with which they can be converted into cash. They are divided into current assets, which can be converted to cash in one year or less; and non-current or long-term assets, which cannot.

 

Here is the general order of accounts within current assets:

 Cash and cash equivalents are the most liquid assets and can include Treasury bills and short-term certificates of deposit, as well as hard currency.Marketable securities are equity and debt securities for which there is a liquid market.Accounts receivable (AR) refer to money that customers owe the company. This may include an allowance for doubtful accounts as some customers may not pay what they owe.Inventory refers to any goods available for sale, valued at the lower of the cost or market price.Prepaid expenses represent the value that has already been paid for, such as insurance, advertising contracts, or rent. 

Long-term assets include the following:

 Long-term investments are securities that will not or cannot be liquidated in the next year.Fixed assets include land, machinery, equipment, buildings, and other durable, generally capital-intensive assets.Intangible assets include non-physical (but still valuable) assets such as intellectual property and goodwill. These assets are generally only listed on the balance sheet if they are acquired, rather than developed in-house. Their value may thus be wildly understated (by not including a globally recognized logo, for example) or just as wildly overstated.

Importance of a Balance Sheet

Regardless of the size of a company or industry in which it operates, there are many benefits of reading, analyzing, and understanding its balance sheet.

 

First, balance sheets help to determine risk. This financial statement lists everything a company owns and all of its debt. A company will be able to quickly assess whether it has borrowed too much money, whether the assets it owns are not liquid enough, or whether it has enough cash on hand to meet current demands.

 

Balance sheets are also used to secure capital. A company usually must provide a balance sheet to a lender in order to secure a business loan. A company must also usually provide a balance sheet to private investors when attempting to secure private equity funding. In both cases, the external party wants to assess the financial health of a company, the creditworthiness of the business, and whether the company will be able to repay its short-term debts.

 

Managers can opt to use financial ratios to measure the liquidity, profitability, solvency, and cadence (turnover) of a company using financial ratios, and some financial ratios need numbers taken from the balance sheet. When analyzed over time or comparatively against competing companies, managers can better understand ways to improve the financial health of a company.

 

Last, balance sheets can lure and retain talent. Employees usually prefer knowing their jobs are secure and that the company they are working for is in good health. For public companies that must disclose their balance sheet, this requirement gives employees a chance to review how much cash the company has on hand, whether the company is making smart decisions when managing debt, and whether they feel the company's financial health is in line with what they expect from their employer.

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