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The Balance Sheet of a company, also called the statement of financial position, is meant to showcase the company’s assets, liabilities and the owner’s equity (Net worth). When compiled with a cash flow statement and income statement, this balance sheet acts as the cornerstone of financial statements for any company.
In case you are a potential investor or a shareholder, it is quite essential to understand the balance sheet and analyze it adequately. Here, in this post, let’s find out about balance sheet analysis and how it can be done properly.
Every business has to come up with three essential financial statements for potential investors to examine, such as:
With this piece of information, investors get to know how much money (assets) the company has, how much they owe (liabilities), and what will be left after merging both of them together (shareholder equity, Book Value, or net worth).
This one states the record of profits earned by the company. It helps in figuring out how much money the company has made or lost.
This one is a record of changes in cash in comparison with the Income statement. This statement helps in understanding where the cash came from and where it disbursed.
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Most of the times, people end up wondering over a question – which are the two parts into which the balance sheet analysis could be divided? To get this answer, let’s first figure out how this sheet is created in the first place.
A balance sheet analysis is generally composed of columns and rows displaying the liabilities and assets of a company and the money that shareholders own. In one column, you will find all the liabilities and assets while in the other, the total amount for each of these categories can be found.
The time period is generally not restricted. While there are companies that release one year’s balance sheet, there are others that put forth multiple years of information. Often, in a balance sheet, assets are listed with respect to how quickly they are going to be converted into cash. And, liabilities get their listing depending upon the due dates.
While looking into a balance sheet, your first goal should be to comprehend the financial health of the company. Preferably, the liabilities, shareholder equity, and assets of a company should be equal. By understanding balance sheet analysis, you can easily determine the following information about a company:
An asset is anything that has value for a company, including investments, tangible objects, and cash. Generally, companies divide assets into two broad categories, and you will find the breakdown of them in the balance sheet:
It is something that can easily be converted into cash within a year, such as stocks, cash, bonds, physical inventory, and prepaid expenses.
Tangible assets that a company can use for several years, such as machinery, equipment, vehicles, buildings, property, and furniture.
Liabilities are the monetary value that a company owes. They are usually meant for covering rent, company salaries, utilities, supplies’ bill, deferred Taxes or loans. Similar to assets, even liabilities are divided into two different categories:
This is an amount that a company owes to others within a short-term, say a year or so. This category includes payable accounts, current debts, ongoing part of long-term debt, and more.
This is the amount that a company has borrowed but isn’t compelled to pay within a short-term. Payable bonds and other long-term debts are counted in this category.
Shareholder equity is the monetary amount that a shareholder or the company’s owner takes. This can easily be calculated by subtracting liabilities from aggregate assets. This simply means that the shareholder equity also comes under the net income, net worth and the overall value of a company.
While more equity signifies more money going into shareholders’ pockets; Negative Equity means that the assets’ value is not sufficient to cover up the liabilities.
Now that the meaning and significance of a balance sheet is clear; know that you must analyze it before making an investment in a company. Moreover, the information available on a balance sheet can also be used along with additional financial documents, like a Cash Flow Statement or an income statement. Finally, combining all of this data and information will help you comprehend whether you should invest in that company or not.